The cost of protecting European corporate debt against default became significantly cheaper on Monday, surprising analysts who were expecting the market to move the other way.
When credit default swap indices hit new highs on Wednesday last week, analysts at the major investment banks predicted the bearish mood had far further to run.
But prices gently retreated during the Thanksgiving period, and on Monday moved decisively lower.
The iTraxx Crossover index of mostly junk-rated corporate debt fell back 9 basis points to 366bp. This means it cost €9,000 less than it did on Friday to protect €10m worth of Crossover debt against default over five years, and $34,000 less than on Wednesday last week, when the index broke through the 400bp mark.
Even bulls were surprised. “We could have gone a lot higher than 400, but we didn’t,” said Suki Mann, head of credit strategy at Societe Generale, saying there had been no real upswing in sentiment to explain the shift.
Significantly, trading volumes were still very light with large gaps between bid and ask prices, even though US traders were back at work.
The rally in the equity markets after positive consumer data in the US on Friday probably contributed to the rally, analysts said, but the real driver is traders covering their shorts rather than taking new positions.
“Nobody really wants to do anything, there’s still a lot of apprehension,” said Mann.
A slew of data releases and comments from the US Federal Reserve planned for this week could invigorate the market. But investors remain edgy about how many subprime skeletons still lurk in the cupboard.
“This is only a correction, as in the medium-term, spreads can still go wider,” said Rajeev Shah, strategist at BNP Paribas. “We believe there are more financials losses to come to the surface. With limited visibility of exposures held by financials, both on and off balance sheet, it is difficult to foresee when normalisation will return to the markets.”
The iTraxx Senior Financial Index – which represents the cost of insuring the senior debt of 25 European financial companies against default — eased 3.25bp to 55bp and the iTraxx Europe index of investment grade corporate debt fell back 2.5bp to 56bp.