European credit derivatives markets sold off sharply on Friday morning, after steep falls overnight in US stocks and credit.
The benchmark iTraxx Crossover index, which consists of 50 mostly junk-rated credits and is an important indicator of sentiment, jumped 35bp to 435bp in early trade. The iTraxx Europe, which tracks 35 investment grade credits, added 8bp to 52bp.
Bid-offer spreads have also gapped significantly: credit default swaps on Portugal Telecom, for instance, was bid at 75np and offered at 115bp, having traded at 65 bp on Thursday, Reuters reported.
The soaring cost of protecting European corporate debt against default led BNP’s strategists to comment,
At current levels the iTraxx indices - Europe, Crossover, LevX - price in default rates so high that it`s difficult to find a justification for them in the historical data provided by the rating agencies…The Crossover at 400bp implies a 6.9% annual default rate (3.4 defaults per year in the index), compared to a 12.9% maximum speculative-grade default rate in 2002 and 5.8% average over the past 5 years. This means that there is *at least* a 1.1% risk premium in the index, compared to a negative risk premium when the index was trading at around 200bp.
