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A degree of calm returned to credit derivatives markets on Tuesday as traders grew more confident in the Fed’s ability to contain systemic risks in the financial system.

After Monday’s turmoil, the cost of protecting European corporate debt against default fell sharply in light morning trade.

Better-than-feared headline results from US investment bank Goldman Sachs helped sentiment, as did expectations of aggressive rate cuts from the Fed later on Tuesday.

The iTraxx Europe, which measures the cost of protecting 125 investment-grade credits against default, fell about 17 basis points to 143bp. This means it cost €143,000 per year to insure €10m of iTraxx Europe debt over five years.
The iTraxx Crossover of mostly junk-rated credits tightened about 34 basis points to 592.5bp.

Financial spreads tightened sharply, reflecting optimism that central banks would not let large banks fail. Analysts pointed to Sunday’s rescue of Bear Stearns, which saw equity-holders suffer dramatically in contrast to credit holders.

“There is a template now that suggests that the worse things get for equity holders of financials the better things may eventually get for the debt holders,” Nick Burns at Deutsche Bank said. “It’s a brave investor that buys financial debt on this basis but it should make investors hesitant about shorting financial credit.”