The cost of insuring European corporate debt against default shot up on Monday morning as traders struggled to digest the news that a large US investment bank was being allowed to fail.
However, market participants said very little trading was actually going on and that market liquidity could be frozen for days or even longer as everyone awaited clarity on the impact of the collapse of such a large counterparty as Lehman Brothers.
Traders and analysts said they hoped there might be some improvement once the US credit default swap markets opened this afternoon, but that that was far from assured.
“This is a big threat to the CDS markets as a whole, which is truly scary because that was the last liquid market,” said one hedge fund trader. “Here, we’re all wondering whether Lehman might have blown up the market.”
There was uncertainty about whether the the special US trading CDS session on Sunday to help mitigate the effects of a potential Lehman collapse would have done any good because news of the bank’s filing came one hour after the midnight deadline after which any deals struck were due to expire.
The main European indices opened for trading with spreads at vastly higher levels than Friday’s close. The iTraxx investment grade index leapt almost 64 basis points to 166bp, while the iTraxx crossover list was more than 90bp wider at up to 640bp.
Spreads later eased back, which some traders said was to do with people covering short positions to lock in profits from the morning’s moves, although others said trading was minimal and it was just investment bank traders marking their own books. By midday, the iTraxx main was 29.6bp wider at 132.25bp and the Crossover 72.4bp wider at 618.2bp according to data from Markit Group.
Banks themselves saw some of the biggest moves with HBoS, Deutsche Bank, SocGen and UBS leading the way wider. Of these HBoS was worst hit moving 35.8bp wider to 283.3bp and UBS least being 27.6bp wider at 166.5bp by midday. All spreads are for five-year contracts.
One thing all participants agreed on was that the costs of funding for banks were significantly higher and would remain so, while it would also be even more difficult for banks to raise new money – both debt and equity – just when they most needed it.
Early indications of how the US markets would open showed the CDX main investment grade index up 34.4bp at 186.2bp.