The cost of insuring European corporate debt against default fell on Wednesday morning, despite sharp declines in global equity markets.
US stocks experienced their worst one-day points fall since February’s sell-off, prompted by disappointing results from Countrywide Financial, the mortgage lender. European equity markets opened weaker, tracking the losses on Wall Street, while Asian stocks also tumbled.
The benchmark iTraxx Crossover index, a key indicator of sentiment in European credit derivatives markets, had tightened about 23bp to 353bp by mid-morning.
Credit market volatility has seen more than 35 companies worldwide cancel or restructure sales of debt in the past five weeks, and some analysts have said the Crossover could breach the 400bp mark if equity markets weaken radically or corporate defaults rise. The index has more than doubled since June.
But Morgan Stanley thinks that at current levels, prices of credit default swaps are overstating the risk of companies missing their debt payments.
Neil McLeish, a credit analyst at Morgan Stanley’s London office, wrote:
Clearly there is a powerful trend established for wider spreads, and it is inherently dangerous to catch falling knives…However we are only covering our short here — not going long.’
The scale of the latest jump in the iTraxx index is normally associated with the end of large corrections in the credit market, and is just less than the sell-off seen in the so-called correlation crisis’ two years ago, according to McLeish. In May 2005, the index reached 452bp General Motors and Ford lost their investment-grade credit ratings, before falling to less than 300bp a month later.
McLeish thinks the potential for increased subprime contagion and the size of the leveraged-loan pipeline are “very widely discussed and, again, we think that much of these concerns are already `in the price’”.
Meanwhile, the iTraxx LevX index, a proxy for investor confidence in high-risk, high-yield loans, snapped a six-day losing streak, rising 0.75 to 97.50, according to Bloomberg data.