While key indices of credit default swaps continued to tighten on Monday, analysts warned that this did not necessarily reflect an improvement in risk appetite.
The cost of insuring the debt of the mostly junk-rated companies in Europe’s iTraxx Crossover index fell 13 basis points to 468bp. The index has fallen more than 100bp since April Fool’s Day.
A wave of short-covering has amplified the spread tightening, analysts said. Speculators started to cut their short positions when the Fed introduced unconventional measures to stabilise the financial system last month. Since then, the tightening has gained momentum as more and more bears got caught on the wrong side of trades.
However, according to Willem Sels, strategist at Dresdner Kleinwort, the market would soon turn as worries about economic problems returned to the fore.
“The sharp improvement of sentiment in CDS markets in the past week does not match the further deterioration of fundamentals,” he said. “We think the positive tone is temporary, but [in a week light on data] it could take another week before we sell off again.”
The iTraxx Europe, which measures the cost of protecting 125 investment-grade credits against default, fell 4bp to about 86bp. This means it cost €86,000 per year to insure €10m of iTraxx Europe debt over five years.
Unlike credit derivatives, cash bonds have continued to trade near their highs, a dislocation that analysts say is unsustainable in the long term.