European credit derivatives markets paused for breath on Thursday morning as investors booked profits gained after the sharp jumps of the past week.The Markit iTraxx Europe index of investment grade corporate debt narrowed by 6 basis points to 152bp, while the iTraxx Crossover index of mostly junk-rated companies fell 9bp to 827bp.
A basis point on a five-year credit default swap contract written on €10 million debt is equivalent to €1000 per annum. This means to take out a contract on the Crossover index at its current price would cost €827,000 every year for five years.
Mehernosh Engineer, a senior credit strategist at BNP Paribas, said:
Investors are taking profits today as we believe things got a bit oversold yesterday. But the overall trend will continue. The Intel results show things are spreading further into the real economy and capital expenditures and there will be further Q4 profit warnings to come.
In the iTraxx Europe index, spreads on Continental AG continued to deteriorate in a week where companies related to the European car industry have come under pressure due to dwindling consumer demand. The German car parts manufacturer’s 5-year CDS widened 23.95bp to 643.33bp.
WPP, the global advertising group, moved wider again by 10bp to 333bp as investors continued to speculate on how the highly-geared company would fare in the global downturn.
While the iTraxx Crossover marginally narrowed, bearish investor sentiment would have been reinforced by a particularly glum outlook from the Moody’s monthly default report released yesterday.
The Moody’s report suggested company default rates could rise to levels not seen since the Great Depression, with the default rate on junk-grade debt potentially rising to 14.9 per cent for next year, the highest level since 1932.
But as companies suffer, canny credit investors can still profit. On the short term investment prospects for credit, Jim Reid, credit strategist at Deutsche Bank, had this to say:
With the recent decline in equity markets in mind, we continue to think that Credit offers sound value relative to other asset classes (especially IG and senior financials on a relative basis), however we did get a reminder overnight that the fundamentals are deteriorating with defaults set to accelerate.
