Credit Swaps in U.S. Surge Most Since 2011 on Stimulus ConcernScott Harrison and Mary Childs
Investor confidence in U.S. corporate credit is plunging the most in almost 20 months on speculation the Federal Reserve is preparing to slow down the pace of its bond purchases.
The Markit CDX North American Investment Grade Index, a credit-default swaps benchmark that investors use to hedge against losses or to bet on creditworthiness, climbed 7.3 basis points to a mid-price of 93 basis points, according to prices compiled by Bloomberg. That’s the biggest jump since the measure rose 8.8 on Nov. 9, 2011, excluding rolls into new series.
Investors are anticipating that a strengthening U.S. economy may spur the central bank, led by Chairman Ben S. Bernanke, to pare the $85 billion in monthly bond buying that has bolstered credit markets. Bank of America Corp. strategists are recommending bearish wagers on high-grade bonds as investors flee exchange-traded funds that own the debt at the fastest pace in more than four years.
“We have a bond bubble, and it’s a massive bond bubble,” Robert Grimm, head of corporate trading in New York at Odeon Capital Group LLC, a boutique broker-dealer for institutional investors, said in a telephone interview. “Bernanke’s trying to let a little air out of that bubble.”
Concern that interest rates will rise further sparked a sell-off in longer-dated corporate debt, leaving about 17.5 percent of the $945 billion of investment-grade bonds in the U.S. with maturities greater than 10 years trading below par, Bloomberg bond index data show. That’s up from about 15.7 percent as of June 7, and 2.9 percent on May 1.
Apple Inc.’s $3 billion of 3.85 percent bonds due in 2043 have dropped 3.2 cents to 87.6 cents on the dollar the past two days, with the yield climbing to 4.6 percent, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. They’ve plunged 11.8 cents since being issued April 30.
Home Depot Inc.’s $1 billion of 4.2 percent notes due in 2043 have fallen 2.9 cents since June 18 to 93.4 cents on the dollar to yield 4.6 percent, Trace data show.
Fed policy makers will cut the central bank’s monthly bond purchases by $20 billion at the Sept. 17-18 meeting of the Federal Open Market Committee, according to 44 percent of economists in a Bloomberg survey.
The survey of 54 economists followed Bernanke’s press conference yesterday, in which he mapped out a timetable for an end to one of the most aggressive easing strategies in Fed history. His remarks prompted economists to predict a faster reduction in purchases: in a June 4-5 survey, only 27 percent of economists forecast tapering to start in September. Speculation the Fed will pare its stimulus pushed the yield on the 10-year Treasury note to as high as 2.47 percent, the most since August 2011.
“It will not be pretty and it will be a rush through the exit doors as the fire alarm has been pulled by the Fed,” Mark J. Grant, managing director at Southwest Securities Inc. in Fort Lauderdale, Florida, wrote in a note today. “There is not enough liquidity in the major Wall Street banks any longer to deal with the amount of securities that will be thrown at them and I expect the down cycle to get exacerbated by this very real issue.”
The 21 primary dealers that do business with the Fed cut their net positions in investment-grade debt due in a year or more by 8.3 percent to $10.3 billion in the week ended June 12, the lowest since the period ended April 24, according to data from the Federal Reserve Bank of New York.
Primary dealers traded 253 fewer times that week than the prior period, lowering the total number of transactions to 119,902, Fed data show.
The Markit CDX North American High Yield Index dropped 1.1 percentage points to 101.5 percent today, the least since December. That increased the annual cost to protect debt in the index by 24.9 basis points to 464.9 basis points.
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.
The U.S. two-year interest-rate swap spread, a measure of debt market stress, jumped 1.65 basis points to 18 basis points. Earlier, the gauge, which typically widens when investors seek the perceived safety of government securities and narrows when they favor assets such as company debentures, reached as high as 19.95 basis points, the most since August 27.
BlackRock Inc.’s iShares iBoxx Investment Grade Corporate Bond exchange-traded fund plunged 2.8 percent the past two days to $113.14, the lowest level since December 2011.
The SPDR Barclays High Yield Bond ETF dropped to $39.49, the least since July 25.
“Volatility will likely be exacerbated by aggressive traders using high-yield ETFs in attempts to profit from short-run price swings in the high-yield market,” Martin Fridson, chief executive officer at FridsonVision LLC, a financial research firm based in New York, said in an e-mailed note today.
The cost to protect the debt of Morgan Stanley from losses increased the most in more than a year as the company said it’s cutting jobs in its commodities business, one of the three biggest on Wall Street. Chief Executive Officer James Gorman said the unit’s revenue the past two quarters was among its worst in 18 years.
Five-year credit swaps tied to debt of Morgan Stanley rose 23.4 basis points to a mid-price of 172.7 basis points, the biggest increase since March 2012, prices compiled by Bloomberg show.