The cost of protecting European debt against default edged slightly higher on Monday, but credit default swap traders barely blinked at Moody’s threat to downgrade $105bn worth of debt issued by structured investment vehicles.
“Is it real news? The ratings agencies are reflecting what the market has already largely priced in,” said Marcus Schueler, credit strategist at Deutsche Bank.
The iTraxx Crossover index of mostly junk-rated corporate debt widened 3 basis points to 353bp, while the iTraxx Europe index of investment grade corporate debt widened 1bp to 53bp.
In another day of light flows, traders said they were looking ahead to key events this week. The European Central Bank and the Bank of England make their interest rate decisions on Thursday, while on Friday the US non-farm payrolls — a key measure of the US economy’s health – are released.
While the market is now all-but-certain that the Federal Reserve will cut US interest rates next week, there is still uncertainty over whether it will cut by 25bp or 50bp.
“Friday’s payroll number could be the defining moment, especially given its close proximity to next week’s FOMC meeting,” said Jim Reid at Deutsche Bank. “Our economists think you will need to see a negative payroll number and a jump in the unemployment rate to see a 50bp cut next week rather than their 25bp forecast.”
While equity markets would undoubtedly rally on the back of a 50bp cut, credit markets are likely to take a more long-term assessment, with traders saying an aggressive cut would not change the fundamental problems stemming from the sub-prime crisis.
“Even if the Fed cuts by 50, nothing will necessarily happen. It may temporarily buoy equity markets but the underlying problem within subprime and ARM resets will continue to linger through 2008,” said Mahernosh Engineer, credit strategist at BNP Paribas.
US Treasury Secretary Henry Paulson is working on a deal to hold interest-payments steady for subprime borrowers in an attempt to stem a cascade of defaults expected next year if planned mortgage rate resets go ahead.
But analysts are not holding their breath. “We are quite sceptical due to several legal and regulatory hurdles the initiative may face and the moral hazard risk that it poses,” Engineer said.