The iTraxx Crossover index, the most widely watched barometer of credit sentiment, powered to a fresh record tight level on Wednesday as equity markets rose and risk appetite remained strong. Some are warning that the pick-up in merger and acquisition activity that is partly responsible for the gains in stocks contains the seeds of the next credit downturn.
But the market has seemed to ignore this in recent sessions as it has moved decisively tighter. The Crossover index was at 189.5 basis points by 1415 GMT, 3.5 basis points lower on the day, a trader in London said.
"I think we can go tighter," he said. "There was so much newsprint in the past couple of weeks dedicated to the end of the market that a lot of people got overly bearish, and that's always a good time to get long." The move tighter then will be helped by those who had taken bearish positions being forced to abandon and reverse them, he said.
Sales of new bonds on Wednesday showed continued strong demand for investment-grade assets too, with holding company IFIL seeing 3.5 billion euros of orders for a 10-year bond by late morning and Volvo Treasury setting a final spread on its 10-year issue at the tight end of initial guidance. Atlas Copco priced a 600 million euro 7-year bond at mid-swaps plus 30 basis points, again at the tight end of guidance.
Meanwhile, a 650 million euro bond sold by Dutch telecom KPN on Tuesday was 4 basis points tighter than at launch, bid at 62 basis points over Bunds, another trader said.
Deutsche Telekom five-year CDS edged 0.5 basis points wider to 22.5 basis points, a level the trader described as "ridiculously tight" despite speculation that it might be bidding for France Telecom's Dutch mobile phone operations. "It should go wider. But as long as the stock market keeps performing like that I think we will see tighter spreads," he said.
The demand for risky assets comes even as some analysts warn that the good times in credit may be coming to an end. "Global M&A activity has recently exploded in volume," said Jim Reid, a credit strategist at Deutsche Bank, in a note to clients.
Spreads, however, have failed to react thus far, possibly because M&A deals are fairly restrained in their structuring. "Given previous cycles, restraint is not likely to last forever and we do not think we are far away from the start of the IG (investment-grade) bear market," Reid wrote.
While the broad market seems impervious to fears of increasingly leveraged balance sheets, some single names are proving more volatile. Five-year credit default swaps on EMI widened to 185 basis points on Wednesday morning after the New York Times said private equity firm Corvus Capital was lining up a bid to trump an agreed deal with Terra Firma. They fell back to 175 basis points in the afternoon after Corvus said it had ruled out an offer.
Trading in EMI's CDS is dominated by concerns over whether a deal or a refinancing will involve the redemption of its existing bonds, which could leave credit derivatives tied to them worthless. However, there could also be fresh debt issued with a guarantee from a more highly leveraged EMI Group Plc that could push CDS spreads sharply wider, analysts at SG CIB warned on Wednesday.
"Without full information, CDS investors, at least in our minds, are playing at a roulette table," they wrote. CDS on BT Group Plc, meanwhile, remained 4 basis points wider on the day at 31.5 basis points after speculation about a buyout of the company gained traction again.
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