U.S. Corporate Credit Swaps Rise Third Day on Fed Taper Concern

A gauge of U.S. corporate credit risk rose for a third day, reaching the highest in six months, as concern mounts the Federal Reserve will start scaling back record bond-buying that has bolstered debt markets.

The Markit CDX North American Investment Grade Index, a credit-default swaps benchmark that investors use to hedge against losses or to speculate on creditworthiness, increased 1 basis point to a mid-price of 94 basis points at 4:12 p.m. in New York, according to prices compiled by Bloomberg. The gauge, trading at the highest level since December, has surged 10 basis points since June 14, heading for its biggest weekly increase since May 2012, excluding rolls into new series.

Investors’ confidence in corporate debt has plunged since Fed Chairman Ben S. Bernanke said on June 19 that economic growth could be strong enough for the central bank to pare $85 billion of monthly bond purchases later this year and end it in mid-2014.

“In a brief period of time you’ve put a lot of strain on the markets,” William Larkin, a fixed-income portfolio manager who helps oversee $500 million at Cabot Money Management Inc., said in a telephone interview from Salem, Massachusetts. “If the Fed acts too early, it can really hurt.”

The credit-swaps index typically rises as investor confidence deteriorates and falls as it improves. The contracts 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.

Bond Purchases

Bernanke, speaking this week after a two-day meeting of the Federal Open Market Committee, said reducing bond purchases would depend on meeting the central bank’s employment and inflation thresholds. The Fed’s stimulus measures, known as quantitative easing, have suppressed interest rates, pushing investors into riskier assets such as corporate bonds in search of higher yields.

The yield on 10-year Treasury notes climbed above 2.5 percent today for the first time since August 2011 and the Standard & Poor’s 500 Index rose on the day after it biggest drop since November 2011.

“You have to expect volatility as the Fed adjusts its profile on quantitative easing as they lead to a more normalized environment,” Morgan Stanley Chief Executive Officer James Gorman said today in an interview. “And that volatility and the Fed actions are a function of the economy recovering. And a recovering economy does a lot of good things for our businesses.”

Market Volatility

The Chicago Board Options Exchange Volatility Index, the measure of options on the S&P 500 known as the VIX, dropped 7.8 percent to 18.9. The gauge surged 23.1 percent to 20.49 yesterday, the highest on a closing basis since Dec. 28. The VIX has soared 67 percent since hitting a six-year low in March.

Policy makers will cut monthly bond purchases by $20 billion at the Sept. 17-18 FOMC meeting, according to 44 percent of economists in a Bloomberg survey.

The risk premium on the Markit CDX North American High Yield Index fell 2.7 basis points to 461.8 basis points.

Sales of company debt this week were below average for the fourth-straight week as the extra yield investors demand to own bonds from the riskiest to the most creditworthy borrowers increased 12 basis points to 238 basis points yesterday, the largest jump since Nov. 1, 2011, according to the Bank of America Merrill Lynch U.S. Corporate & High Yield Index.

American Equity

American Equity Investment Life Holding Co., the seller of fixed annuities, withdrew a $250 million bond offering as investors demand higher rates.

“Conditions in the debt capital markets led us to the conclusion that we should not proceed,” Chairman D.J. Noble said today in a statement from the West Des Moines, Iowa-based insurer. “We will continue to monitor developments and may return to the market when conditions are more favorable.”

The insurer announced the offering on June 18 and said it had planned to use the proceeds to repay debt and for other expenses. American Equity is rated BB+ by S&P, one level below investment grade.

The average relative yield on speculative-grade, or junk-rated, debt fell 0.4 basis point to 564.2, Bloomberg data show. High-yield, high-risk debt is rated below Baa3 by Moody’s Investors Service and less than BBB- at S&P.

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