The European credit market saw renewed weakness on Monday, fretting still over US subprime mortgages and leveraged loans, but retreated from its widest level of the day as US stocks gained and US credit markets moved off their lows.
The iTraxx Crossover index, the most widely watched indicator of European credit sentiment, was 10 basis points wider at 353 basis points by 1505 GMT, having traded as wide as 366 basis points earlier, dealers said.
The index is close to 85 basis points wider since last Monday and around 160 basis points wider than mid-June - a staggering move for just six weeks - due to continued, persistent fears over losses from the US subprime mortgage market and trouble in financing LBOs.
Spreads stepped back in on Monday afternoon thanks to relative strength in the US markets - with even the much-maligned ABX subprime mortgage index off its lows - but there may be worse to come.
"So far we have not seen the final shakeout," said Jochen Felsenheimer, head of credit strategy at UniCredit (HVB). While it is possible that the market could see a temporary rally, investor pessimism means that it is difficult to justify taking a positive view, he said, with traders using any tightening as an opportunity to set new short positions.
"At any time there might pop up new negative news from subprime," Felsenheimer said. "Always and at any time, you have something around that can immediately trigger a 10-15 basis point widening in the Crossover. That's obviously an ugly environment to take on long credit exposure."
While many in the market are focused on the risk that the Crossover could move quickly to 400 basis points if structures are forced to unwind, some are warning that a further milestone is in sight. "Anyone who still wants to insist that all we have is a little case of sub-prime weakness should be ashamed of themselves," said RBS credit strategist Bob Janjuah in a note entitled "Can Crossover trade at 500?"
The focus has shifted towards higher-rated debt such as Alt-A loans, mortgages that fall between "prime" and "subprime" loans in quality, and whether they may be next to crumble. "Subprime may have been the first area to roll over, but pain has, is and will continue to spread to the Alt-A and Prime sectors of the US housing market," Janjuah added.
"I do think Crossover can trade at 500," he said, although he added: "A move to 500 is not yet probable, rather for now it is still just 'very possible'". Such a move would be fuelled by a rise in defaults or a significant sell-off in stock markets, Janjuah said.
So far equities have powered ahead, mostly shrugging off credit market turmoil, with the Dow Jones industrial average setting a record close above 14,000 points just last week. The index rose on Monday, and by 1513 GMT was up close to 0.7 percent.
The volatility in the high-yield market took its toll on global power firm InterGen, which raised yields on its three-part bond sale for the second time and cut the size of the offering by $100 million.
InterGen now plans to price $1.2 billion to $1.3 billion of 10-year bonds at 99.189 with a coupon of 9 percent to yield 9.125 percent; 175 to 200 million pounds of 10-year bonds at 99.209 with a coupon of 9.5 percent to yield 9.625 percent; and 160 to 185 million euros of 10-year bonds with a coupon of 8.5 percent to yield 8.625 percent, a banking source said. Pricing below par is unusual for new high-yield bond issues and is a further sign of the stress the market has come under.
In the cash bond market, the FTSE Euro Corporate Bond Index showed investment-grade corporate bonds in euros yielding an average 52.5 basis points more than similarly-dated government bonds at 1513 GMT, 1.4 basis points more on the day.
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