European credit derivatives markets rallied sharply on Wednesday, tracking a strong session in US equity and credit markets overnight.
Goldman Sachs stoked confidence among traders of credit default swaps when it said it expected no significant writedowns related to the US subprime mortgage market. HSBC added to the upbeat mood with expectation-beating third-quarter profits which it said “more than offset” $3.4bn of losses from its American consumer finance business.
The news soothed nerves that have been on edge for weeks over fears of further writedowns related to the financial sector’s exposure to the subprime mortgage market and related securities.
The cost of protecting corporate debt against default fell sharply, dropping off from levels in striking distance of a two-month high.
The iTraxx Crossover, a closely watched measure of risk appetite, tightened by about 15.5 basis points to 360bp in morning trade, meaning it now costs €360,000 annually to protect €10 million worth of mostly junk-rated corporate debt against default.
However, some traders warned against taking too much confidence from Goldman Sachs and HSBC. “There are still writedowns to be had, there may still be potential unwinds as a result of SIVs, the risk of further ratings downgrades is very high, and the money markets are still broken,” said David Brickman at Lehman Brothers. “These problems haven’t gone just because of the good news yesterday.”
The iTraxx Europe index of 125 investment grade names tightened by about 4.75bp to 49.75bp, against a close of 54.5bp on Tuesday.