Europe Bond Risk Surges to Two-Month High as Fed Signals QE Exit

The cost of insuring European corporate bonds against losses surged to the highest in more than two months after the Federal Reserve confirmed it will begin withdrawing stimulus if the economy continues to improve.

The Markit iTraxx Europe Index of credit-default swaps on 125 companies with investment-grade ratings rose 12 basis points to 119 at 1:59 p.m. in London, the highest level since April 4, Bloomberg data show. The Markit iTraxx Crossover Index of contracts on 50 high-yield companies increased 44 basis points to 487, the most since March 20.

Fed Chairman Ben S. Bernanke said the central bank would start winding down its $85 billion in monthly bond purchases later this year and will end them completely by mid-2014 as long as the world’s largest economy performs in line with its projections. Credit risk began rising in May as Bernanke signaled a potential tapering of the stimulus that drove credit-default swaps on European corporate debt to the lowest in more than three years.

“The market is focused on rising rates,” said Alberto Gallo, head of European macro credit research at Royal Bank of Scotland Group Plc in London. “The weakness is definitely due to the less dovish tone from the Fed.”

The average yield investors demand to hold European corporate bonds is holding near a 3 1/2-month high at 2.04 percent, Bank of America Merrill Lynch index data show, after rising from a record 1.72 percent reached May 17. The spread over benchmark government debt is unchanged at 125 basis points, near the highest in 1 1/2 months, according to the data.

Risk Outlook

“The Fed have just made the market even more sensitive to data than it was previously,” Jim Reid, head of fundamental strategy at Deutsche Bank AG in London, wrote in a note to clients. “We now think this will be a difficult few weeks for risk, especially if the data is on the stronger side.”

The Markit iTraxx Financial Index linked to senior debt of 25 banks and insurers rose 18 basis points to 171, while the subordinated index climbed 25 basis points to 252, the highest since April 26. An increase signals deterioration in perceptions of credit quality.

A basis point on a credit-default swap protecting 10 million euros ($13.2 million) of debt from default for five years is equivalent to 1,000 euros a year. Swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements.

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