Confidence Returning as Revealed in Country Risk: Credit Markets

Confidence Returning as Revealed in Country Risk
Companies from Rio Tinto Group to Philip Morris International Inc. that issued $24 billion of investment-grade debentures last week paid an average of 1 basis point more in relative yield than investors accepted for their outstanding bonds with similar maturities, according to Barclays Plc data. Photographer: Daniel Acker/Bloomberg

From the U.S. to Germany and China, the risk of owning sovereign bonds has tumbled to the lowest in a year as the specter of another systemic crisis that drags down the world’s economy diminishes.

The average cost of credit-default swaps insuring the debt of about 50 nations tracked by Bloomberg fell to 159 basis points, from as high as 250 basis points in November. Swaps on China are at the cheapest in five months, while Germany is at a 13-month low and the U.S. is at levels not seen since May.

Confidence in government debt has improved since June amid mounting speculation that European policy makers will step up efforts to curb the region’s debt crisis and as reports from jobs to retail sales in the U.S. underpin growth. The rally strengthened when European Central Bank President Mario Draghi vowed on July 26 to do “whatever it takes” to save the euro and signaled that would include buying government bonds.

“All hopes are pinned very much on the ECB and that’s fueling the rally in sovereign credit,” said Nicholas Spiro, the managing director of Spiro Sovereign Strategy in London. “Europe is very much still the focal point for market anxieties and what happens in Europe has knock-on effects elsewhere.”

Peripheral Risk

Swaps tied to the debt of Spain and Italy, two of the euro-region’s so-called peripheral countries, fell to the lowest since April on speculation efforts to cap their bond yields will buy time for their economies to heal. Contracts on Spain dropped to 445 basis points from a record 647 on July 25, while Italy declined to 394 from this year’s high of 580 on June 1.

Japan plunged to a 15-month low of 79 from 110 on June 4, while contracts on China tumbled to 104 from 143.5 on the same day, prices compiled by Bloomberg show. The U.S. fell to 40 from a five-month high of 51 on June 22 amid signs of strength in the world’s largest economy.

Elsewhere in credit markets, Aetna Inc. obtained a $2 billion bridge loan to finance the health insurer’s acquisition of Coventry Health Care Inc. General Electric Co. sold $1.13 billion of bonds backed by credit-card payments after doubling the offering. The cost to protect against losses on company debt in North America and Europe rose the most in almost three weeks.

Corporate Risk

The Markit CDX North America Investment Grade Index, a credit-swaps benchmark that investors use to hedge against losses or to speculate on corporate creditworthiness in the U.S. and Canada, climbed from about the lowest in more than 15 weeks, rising 1.4 basis points to 100.1 basis points as of 11:40 a.m. in New York, according to prices compiled by Bloomberg.

In London, the Markit iTraxx Europe Index of 125 companies with investment-grade ratings jumped 5 to 142.2.

Both indexes, which gained the most since Aug. 2, typically increase as investor confidence deteriorates and fall as it improves. Credit swaps pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

Goldman Sachs Group Inc. and UBS AG are arranging the 364-day financing for Hartford, Connecticut-based Aetna, the insurer said in a regulatory filing today.

Aetna will pay interest on the debt tied to ratings, the company said, which begins at one percentage point more than the London interbank offered rate when ratings are A3, A- and A- by Moody’s Investors Service, Standard & Poor’s and Fitch Ratings, respectively. The rate increases by 0.25 percentage point if the grades deteriorate.

GE Issue

GE’s credit-card securities offering was originally $563 million, according to a person familiar with the deal who asked not to be identified because the terms aren’t public. The Fairfield, Connecticut-based company paid 43 basis points more than the benchmark swap rate on top-ranked securities maturing in about five years, the person said.

Sales of asset-backed securities linked to credit-card debt in 2012 are at the highest level in two years, according to Wells Fargo & Co. Companies issued $18.9 billion of the bonds through Aug. 15, up from about $10 billion during the same period of 2011, the Charlotte, North Carolina-based analysts said in an Aug. 20 report.

Bonds of Caracas-based Petroleos de Venezuela SA, or PDVSA, are the most actively traded dollar-denominated corporate securities by dealers today, with 28 trades of $1 million or more of the state-oil company’s debt as of 11:34 a.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

Softening Stance

Confidence is returning to sovereign-debt markets as euro-area leaders take steps to contain the crisis that’s weighing on the global economy.

This week the continent’s leaders are engaged in a round of diplomacy before French President Francois Hollande and German Chancellor Angela Merkel meet to discuss the crisis in Berlin tomorrow. Merkel has signaled a softening in her stance toward Draghi’s rescue plan for Italy and Spain.

“The euro-zone crisis has penalized global growth,” said Christian Schulz, an economist at Berenberg Bank in London. Potential intervention by the ECB “reduces the risk of major defaults in the euro zone and also reduces the chances of another global financial crisis,” he said.

IMF Forecast

The International Monetary Fund on July 16 cut its global growth forecast for 2013 to 3.9 percent from a 4.1 percent estimate in April, citing risks that U.S. and European officials mismanage their responses to the problem of excessive debt.

Economic indicators in the U.S. such as employment and retail sales are improving, though the jobless rate marked its 42nd straight month above 8 percent in July and the country faces a so-called fiscal cliff of higher taxes and spending cuts during an election year.

In China, home prices are rising even as growth in the world’s second-largest economy slows, while in Germany a senior lawmaker with Merkel’s party indicated yesterday that the government may be willing to make concessions to Greece on the deficit-reduction targets that are a condition of its bailout.

Germany’s Bundesbank has opposed the bond-buying plan, while Finance Minister Wolfgang Schaeuble said Aug. 18 that solving the crisis mustn’t become a “bottomless pit” for the country.

The drop in swap prices “is almost entirely driven by the ECB and by the perception that there is going to be a more credible and effective interim backstop, and the jury is still very much out on that one,” Spiro said. “It looks very much like the market is setting itself up for disappointment.”

Saving Euro

Default risk of countries that will shoulder the burden of saving the euro is also declining as optimism a resolution is at hand outweighs the potential costs of a rescue. Contracts on Germany fell to 54, the lowest since July 22, 2011, from as high as 111 in June, Bloomberg prices show.

At the same time as investors bet a euro-region rescue plan will be good for Germany’s creditworthiness, fund managers are selling the country’s bonds because they’re a defensive haven asset favored in times of adversity. Yields on the nation’s 10-year bund rose 35 basis points in the past month to 1.53 percent.

“If you think a euro-zone make-up is going to cost Germany less than a euro-zone breakup, you’d expect German CDS to come in,” said Lyn Graham-Taylor, a fixed-income strategist at Rabobank International in London. “A sell-off in German debt is a risk-on play that the euro zone will survive.”

Brazil to China

The average of credit swaps on countries from Brazil to China excludes non-investment grade governments such as Argentina and Portugal, though many of those nations are also rallying. Swaps on Portugal, which was the third of the five European countries that have been bailed out, dropped to a 15-month low of 658 from a record 1,554 on Jan. 30 as the government reforms its economy.

Credit-swap trade volumes on the euro region’s most indebted governments have fallen since the sovereign crisis started, while those on core countries have risen.

Contracts outstanding protect a net $23 billion of French debt and $22 billion of German bonds, compared with $20 billion for Italy, $13 billion for Spain and $4 billion for the U.S., according to the Depository Trust & Clearing Corp.

The Markit iTraxx SovX Western Europe Index of credit swaps on 15 governments was at 223 basis points, the lowest since the latest series of the gauge started trading in March and three basis points off the level the measure dropped to after Greece was removed.

“We have seen a strong tightening of sovereign spread and a general move of steepening of curves,” said Francois Popon, co-head of credit trading at Societe Generale SA in London. The prospect of “the ECB intervening on the short end of the curve on Italy and Spain is driving this move.”

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