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Credit analysts have heaped scepticism on the recent rally in credit derivatives, but there were few signs on Friday that the positive momentum was letting up.

The iTraxx Crossover index, a closely-watched measure of risk-appetite, broke back below the 500 basis point mark in morning trade.
The index, which measures the cost of protecting 50 risky European companies’ debt against default, shed 30bp to 480bp. The last time it traded below 500bp was at the start of February.

The iTraxx Main also continued its tightening streak, falling 6.8bp to 90bp.

The indices were driven to record high levels in March, led by huge widening in credit default swaps on financial companies as investors, betting on financial system meltdown, paid huge premiums to protect banks’ debt from default.

Since the market began to rally, financials have again led the way, tightening further and faster that their non-financial counterparts. Since the market’s peak on 17th March, the average tightening for senior financial credit default swaps has been 77bp while non-financials have shed 49bp.

The Fed’s many and varied attempts to support banks and brokers has played a part in the sentiment-shift, prompting leveraged funds who were heavily short the market to close out their positions, say analysts at BNP Paribas.

The bearish team argued on Friday that the CDS market, which last month was pricing in a far more alarmist scenario than the cash bond market, now looks too positive:

From an investment perspective, we would rather follow the cash market. Over the next month…a weak set of earnings from the financials (especially the weakest links like autos, the monolines, Walmu, CIT, Rescap, etc.) could lead to us test the recent wide spread levels once again over the summer.