If credit market participants thought they were already pricing in worst-case scenarios, Monday’s rumours (later denied) that Bear Stearns was in serious trouble prompted a re-think.
“The market has already priced in some pretty bad scenarios. Now we’re starting to grow worried about a financial institution in the US failing,” said Andrea Cicione. “The market is afraid it could be a major one.”
On Tuesday the iTraxx Europe, which measures the cost of protecting 125 investment-grade credits against default, edged 1.5 basis points higher to 156bp. This means it cost €156,000 per year to insure €10m of iTraxx Europe debt over five years.
By contrast, the iTraxx Crossover, an index of 50 mostly junk-rated credits, fell back by 13bp to about 624bp.
In part this dislocation between the two indices is driven by the unwinding of structured products, which requires bulk-buying investment-grade protection.
But the investment-grade index is also feeling the worst of the pain because is contains more financial companies’ debt — and market jitters about financial institutions intensify by the day.
Despite Bear Stearns’ fervent denial that it was struggling to access capital on Monday, its credit default swaps remained very high. Protection against default for one year was at around 800bp, according to BNP Paribas indicative prices, while 5 year protection was around 610bp.
This inversion of the usual CDS pattern (whereby longer-lasting protection costs more) means the market is predicting serious trouble in the near-term.
