Spreads in the European credit markets tightened on Tuesday, amid subdued trading, as investors bet the strong sentiment of the past few months was unlikely to be upset anytime soon.
Low equity volatility and restrained bond supply, plus a well-charted path for rises in interest rates, fuelled demand for fixed income securities across the board, traders said.
"We are slightly stronger pretty much in all sectors," said a trader in London. "The sell-off that everybody has been waiting for has failed to materialise, so the shorts are coming back into the market."
Five-year credit default swaps on telecommunications bellwether Deutsche Telekom tightened 1.0 basis point to 41 basis points, the trader said, meaning it costs an annual 41,000 euros to insure 10 million euros of the company's debt against default.
Five-year protection on rival France Telecom was also a basis point tighter, at 44 basis points, he said. Elsewhere, Portugal Telecom attracted some buying interest after British giant Vodafone said it opposed the potential 11.1 billion euro ($13.3 billion) take-over of the company by conglomerate Sonae. Five-year default swaps on PT were 5 basis points tighter at 150 basis points, a trader said.
The new iTraxx Series 5 indexes continued their impressive form, tightening for a second straight day after their launch on Monday. The main iTraxx Europe index was around half a basis point tighter at 35.25 basis points.
Vivendi Universal was buffeted after UBS said a leveraged buyout looks attractive for the company - its CDS moving in the opposite direction to its rising shares with five-year protection five basis points wider at 157 basis points.
In the retail sector, Boots and Kingfisher were beneficiaries of the benign atmosphere, both tightening 2 basis points to 41 and 59 basis points respectively.
Against the grain, the cost of default protection on Rentokil fell sharply on Tuesday as investors had a eureka moment concerning a new corporate structure which means the company's bonds will come under two names until 2008.
With the British services group marketing a 10-year sterling note, investors realised in early trade that the paper will be sold out of a new entity, formed last year, called Rentokil Initial.
That means the old company, Rentokil Initial 1927, which has $1.1 billion of multi-currency bonds, is unlikely to issue again and will be left with no debt when the last of its current outstandings is redeemed in 2008.
Five-year credit default swaps on Rentokil Initial 1927 traded as much 30 basis points tighter at 30 basis points, meaning its cost of default protection halved to 30,000 euros per 10 million euros face amount.
"Most galling is the fact this information has been in the public domain since December," said Dresdner Kleinwort Wasserstein, in a note.
Rentokil later in the day sold the expected 10-year sterling bond, with a deal totalling 300 million pounds, yielding 133 basis points over gilts. That is tighter than original spread guidance of about 140 basis points, suggesting investors liked the paper.
Elsewhere in the primary market, Swiss chemicals maker Clariant was roadshowing its debut euro bond, which is likely to contain even more watertight safeguards than a string of recent deals which have protected investors against debt-heavy buyouts.
An official at one of the lead managers said the benchmark, intermediate maturity bond would contain a "change of control" clause allowing investors to sell the bond back to the company if a take-over sends its credit rating to "junk".
Such terms have become widespread as bond investors worry about an upsurge in deal-making. A newspaper report in February claimed Clariant was in advanced talks with private equity firms.
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