Thursday, June 28, 2007

US subprime gloom weighs on European CDS trading

US subprime gloom weighs on European CDS trading
By Gillian Tett
Copyright The Financial Times Limited 2007
Published: June 28 2007 03:00 | Last updated: June 28 2007 03:00

Sentiment in the European credit derivatives market fell to the lowest point seen for several months yesterday, as investors in the corporate credit world began to fear that some of the jitters seen in the US mortgage market could spread to other financial arenas.

The deterioration in sentiment follows a similar decline in American credit derivatives earlier this week, with a particularly marked movement in the price of instruments linked to financial institutions that are involved in the subprime sector.

Taken together, the movement suggest that although the corporate credit world has been relatively insulated so far from the market turmoil of recent weeks, this may be starting to change.

However, analysts remain hotly divided about whether this simply reflects a return to a more normal level of risk pricing in the corporate sphere, after an unusually benign spell - or an ominous slide towards a more widespread bout of turmoil.

A good indicator of sentiment in the European corporate credit sector comes from the so-called iTraxx index, which tracks the cost of buying insurance against default, via credit default swaps (CDS), on a basket of sub-investment grade corporate bonds.

This series yesterday swung out to touch 232 basis points - a price which means that it costs €232,00 to insure €10m ($13.4m) of debt each year - according to Deutsche Bank. This is 17bp higher than the level seen on Tuesday, and comes after several days of steady increases. Earlier this summer, the index was trading below 200bp.

The index later swung back slightly during the day towards 228bp. However, sentiment in the market remained distinctly jittery. Marcus Schueler, analyst at Deutsche Bank, characterising the trading atmosphere as "fast."

In the US, the comparable American indices did not exhibit such a marked swing in early market trading. However, investors are keeping a particularly close eye on the level of trading around financial institution CDS.

In recent days, the cost of insuring against default on Bear Stearns has swung out to about 54bp - from the mid-40s earlier this month - according to Phoenix Securities, an independent interdealer broker.

Meanwhile, the CDS of groups such as Goldman Sachs have also risen to about 37bp, while the Lehman Brothers' CDS have touched 39bp.


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