Bonds: crossover inches wider

European credit spreads inched wider early on Monday, backing up after last week's sharp rally, as traders and analysts weighed up whether the market was returning to normality after the summer's turmoil. Trading was thin in secondary markets, however, with the primary market continuing to set the pace as Illinois Tool Works launched a long-awaited euro bond sale.
By 0735 GMT, the iTraxx Crossover index, made up of 50 mostly "junk"-rated credits, was 3.5 basis points wider at 304.5 basis points, a trader said, in a market that he described as "unexceptional". Last week European credit spreads rallied sharply after a bigger-than-expected 50-basis-point cut in US interest rates and broker earnings that painted a relatively positive picture.
"In a crisis of confidence, the feel-good factors make a world of difference," strategists at Citigroup wrote in a note to clients. "The last week has provided them in spades: the broker numbers, central bank interventions and, perhaps most importantly of all, tentative signs of improvement in the money market. "Put together, we believe these factors significantly increase the probability that the worst is now behind us," they said.
However, they warned that the market still faced "hurdles" in the shape of the third-quarter earnings season, an abnormal money market, the supply pipeline and, not least, the feedback on the real economy. Strategists at Dresdner Kleinwort argued that the rally in spreads last week was overdone.
"There is still negative news coming out," they wrote in a note to clients. "We continue to believe that even once money markets have stabilised, the markets' attention is then likely to turn to the US slowdown in the medium term."
After a roadshow earlier in September, Illinois Tool Works on Monday launched a maximum 750 million euro 7-year bond, with pricing due later in the session, a banker familiar with the sale said.
Initial guidance is in the area of mid-swaps plus 70 basis points. Last week saw the European investment-grade primary market reopen in style, with utility E.ON garnering huge orders for a 3.5 billion euro two-part bond sale.
In the cash bond market, the FTSE Euro Corporate Bond Index showed investment-grade corporate bonds in euros yielding an average 74.7 basis points more than similarly-dated government bonds at 0755 GMT, 1.1 basis points less on the day.
In underlying government bond markets, the yield on the interest rate sensitive two-year Schatz was 4.047 percent, 1.1 basis points less on the day. The 10-year Bund yielded 4.362 percent, 0.5 basis points more. The 10-year euro swap rate was 4.693 percent.