European credit spreads widened further on Wednesday, with the Crossover index hitting a two-year high, a day after Bear Stearns said two hedge funds that had bet on the US subprime mortgage market had lost almost all their value.
The mood spread to stock markets as well, with European indexes down sharply and the Dow Jones industrial average retreating from the record highs it scaled on Tuesday.
The credit market was steadied somewhat as core consumer price inflation data in the US emerged in line with expectations, and analysts said testimony from Federal Reserve Chairman Ben Bernanke offered few fresh clues on monetary policy and could be read as offering comfort to the market.
The iTraxx Crossover index, the most widely watched indicator of European credit market sentiment, was at 312 basis points by 1500 GMT, 22 basis points wider on the day, seemingly having found a point of equilibrium after trading between 305 and 315 for much of the session.
The index earlier traded as high as 324 basis points, a new record high for the current contract and the highest level for an on-the-run contract for two years.
Further volatility may lie ahead. "I think it's only a temporary settle at around 310 bps for the Crossover index, because the headlines will continue to get worse," said Mehernosh Engineer, senior credit strategist at BNP Paribas. "The market is concentrating on the Bear Stearns headline but there are quite a few other things that have come out."
He cited comments from Moody's Investors Service saying delinquency rates on Alt-A mortgages were rising quickly, and that the agency had not been hired for 75 percent of commercial-mortgage backed securities ratings as they had been asking for extra enhancement. "So: what we did in subprime we are duplicating in Alt-A and then in commercial mortgages also," he said.
Others too, took a gloomy line on the outlook. "Fundamentally, the outlook remains bearish: subprime woes in the US, concerns over CDO transparency and the high-yield pipeline from earlier leveraged deals all threaten to weigh on spreads," credit strategists at Royal Bank of Scotland said in a note to clients.
Dealers said there were renewed nerves during the afternoon that there could be further problems similar to that experienced by Bear Stearns to come to light.
In the cash bond market, the FTSE Euro Corporate Bond Index showed investment-grade corporate bonds in euros yielding an average 49.5 basis points more than similarly-dated government bonds at 1528 GMT, 0.8 basis points more on the day.
By 1420 GMT, the cost of insuring debt of British retailer J Sainsbury had risen to 115.5 basis points, a jump of around 40 basis points on the day, a trader said.
Sainsbury's five-year credit default swaps widened to as much as 120 basis points in earlier trading after the company confirmed Qatari investment fund Delta Two had made a bid approach. "There's no certainty that it's going to go ahead but if it does we'll probably go a lot wider," the trader said.
Others however, said they were concerned that even if a take-over went through, there might not be debt deliverable against the contracts, potentially rendering them worthless. Meanwhile, CDS on health and beauty retailer Alliance Boots' remained 20 basis points wider at 390 basis points as the market awaited further news on the 9 billion pounds of debt backing its leveraged buyout.
The deal is an important test of investor sentiment due to its sheer size and because it does not contain standard leveraged loan covenants, having just one so-called maintenance covenant.
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