Credit Swaps Decline as Fed Tapers Bond Purchases to $75 Billion

A gauge of company credit risk fell after the Federal Reserve said it will cut its monthly bond purchases by 12 percent to $75 billion as it signaled confidence in an improving labor market.

The Markit CDX North American Investment Grade Index, a credit-default swaps benchmark used to hedge against losses or to speculate on creditworthiness, declined 2.3 basis points to 67.7 basis points as of 3:57 p.m. in New York, approaching a six-year low reached last week, according to prices compiled by Bloomberg. The swaps measure typically falls as investor confidence improves and rises as it deteriorates.

Chairman Ben S. Bernanke affirmed investor optimism that the U.S. economy will continue to recover even as the central bank maintains the bulk of its unprecedented stimulus efforts intended to spur growth after the worst recession since the 1930s. The central bank’s decision follows a report earlier this month that the jobless rate fell to 7 percent in November, a five-year low, as employers added a greater-than-forecast 203,000 workers to payrolls.

“What Bernanke has basically done is acknowledge that the economy is improving and quite frankly investors are getting it,” Anthony Valeri, a market strategist in San Diego with LPL Financial Corp., said in a telephone interview. “They’re still accommodative, buying $75 billion a month, and at the same time have acknowledged the strength in the economy.”

Taper Breakdown

The Fed’s purchases will be divided between $40 billion in Treasuries and $35 billion in mortgage bonds starting in January, down from $45 billion of government securities and $40 billion of the home-loan securities it’s buying each month now.

The credit-swaps benchmark, which has averaged 79.8 basis points this year, reached a six-year low of 67.3 on Dec. 9. 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.

The risk premium on the Markit CDX North American High Yield Index, tied to the debt of 100 speculative-grade companies, decreased 10.8 basis points to 329, Bloomberg prices show. High-yield, high-risk bonds are rated below Baa3 by Moody’s Investors Service and less than BBB- at Standard & Poor’s. A basis point is 0.01 percentage point.

Relative yields on bonds of the riskiest retailers are climbing as consumers send mixed signals on their willingness to spend during the year’s busiest shopping period.

Toys ‘R’ Us

The extra yield investors demand to own the debt of junk-rated retailers instead of similar-maturity Treasuries climbed to 457 basis points yesterday, up 74 basis points from a six-year low reached in May, according to the Bank of America Merrill Lynch US High Yield Super Retail Index. Toys “R” Us Inc.’s $400 million of 7.375 percent bonds due October 2018 fell to their lowest since August 2009 after the company said its net loss widened in the three months ended Nov. 2.

Spreads on the Bank of America Merrill Lynch index have increased from 383 basis points in May, the lowest since July 2007, and have climbed from 444 basis points on Nov. 29.

The increase compares with a drop in spreads on the Bank of America Merrill Lynch US High Yield Index to a six-year low of 409 basis points on Dec. 16 and a plunge in the Bank of America Merrill Lynch US Non-Food & Drug Retail Index to 102 basis points yesterday, the least since May 2011.

Holiday ‘Apprehension’

Investors are demanding a bigger cushion to own the retailers’ bonds even as spreads on the broader high-yield market and on debt issued by investment-grade retailers plunge to multi-year lows. While November sales rose the most in five months, business on the Black Friday weekend that kicked off the holiday shopping season is projected to have declined for the first time since 2009.

“There’s some apprehension about the trajectory of the 2013 holiday season,” James Goldstein, a New York-based analyst at CreditSights Inc., said in a telephone interview. “When people start to question the success of the holiday season, there’s a natural shift away from some of the riskier names in retail.”

Bonds of Toys “R” Us dropped after the retailer said its net loss widened in the three months ended Nov. 2 as domestic comparable store sales dropped 5.2 percent. Toys “R” Us’s 2018 bonds fell 3.75 cents to 73.75 cents on the dollar at 1:13 p.m. in New York to yield 15.27 percent, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The Wayne, New Jersey-based retailer said in a statement yesterday that its net loss in the fiscal third quarter widened to $605 million from $105 million a year earlier.

Spreads on global corporate bonds have narrowed 32 basis points this year to 190 basis points, or 1.9 percentage points, after reaching as high as 235 in June, according to the Bank of America Merrill Lynch Global Corporate & High Yield Index.

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