European credit markets held relatively firm on Monday, against tumbling shares hit by fears in the British financial sector, ahead of a US interest rate decision and earnings releases from US major financial houses.
Northern Rock, the embattled British mortgage lender, retained its position in the spotlight after Fitch Ratings cut the company's issuer default rating for the second time - following an initial downgrade to A on Friday - to A-, the seventh-highest investment grade.
Fitch said its downgrade was "based on the increased negative sentiment from wholesale market participants and retail depositors, which has severely strained the bank's funding options". Thousands of customers queued outside branches of Northern Rock for the third day to withdraw savings, after the Bank of England gave Northern Rock an emergency loan facility, despite assurances that their money was safe and that the company was solvent.
By 1400 GMT, five-year credit default swaps on Northern Rock were at 210 basis points versus 155 basis points late Friday, having been trading in a tight 100 to 110 basis point range for most of the month prior to the BoE funding news.
"The bulk of clients we spoke to on Friday thought the BoE injection essentially made a take-over an immediate inevitability and nobody wanted to be caught with a short," said Sean Burton of credit trading at UBS in a global client conference call on Monday.
"However, people are now more and more concerned about the funding of the takeout so people are starting to notionally cover their long positions," Burton said. In comparison, CDS in other wholesale funding names such as Icelandic bank Kaupthing were trading up at 160 basis points while Bradford & Bingley trading up at 130 basis points, he said.
"The curve for Northern Rock is very inverted. Anyone looking for one-year or two-year protection is probably going to be paying 500 to 600 basis points if they can find it. Cash bonds are trading in much the same way. Senior cash bonds are trading at the 500 to 600 level, simply because it is a matter of getting rid of your risk."
By 1415, the Crossover index, closely watched as an indicator of European credit risk appetite and made up of 50 mostly "junk"-rated credits, was unchanged at 330 basis points by 1525 GMT, a trader said. The investment-grade iTraxx Europe index nudged wider 0.5 basis points to 47.5 basis points. "Credit markets are fairly subdued. The Crossover has hardly moved despite weakness in the equity markets in the morning," said Rajeev Shah, credit analyst at BNP Paribas.
"Volumes are light. The market is just waiting for the Fed tomorrow and the US broker earnings, beginning with Lehman," Shah said. The US Federal Reserve is widely expected to lower interest rates on Tuesday to cushion the US economy from current market turmoil. The central bank has not lowered rates by more than 25 basis points at a single meeting in almost five years, but this time some analysts feel a deeper cut is needed.
"The roll is also coming up on Thursday, which is also a technical factor usually in the past which has helped CDS indexes to tighten ... as investors buy the new, more liquid index," said Shah, referring to the rollover of the iTraxx indexes on Thursday.The iTraxx financial senior index was 0.5 basis points tighter at 42.5 basis points. In primary markets, Austria is preparing to sell a minimum 3 billion euro 10-year bond at midswaps minus 23 basis points.
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