US corporate bond spreads tightened and junk bond prices rose on Friday on increased hopes for an interest rate cut and news of a US Treasury plan to stem subprime mortgage defaults.
The end of the fiscal year for a number of large broker-dealers also helped sentiment, as some investors anticipated there would be more potential for risk-taking as a New Year begins, said Rizwan Hussain, investment-grade credit strategist for Morgan Stanley.
"The speculation could be that as we flip into a new fiscal year, balance sheet constraints become less of an overhang on the market, and that allows broker-dealers to warehouse more securities," he said. Investment-grade corporate bond spreads were tighter across the board, with some financial sector bonds 10 to 15 basis points tighter, traders said.
Increasing hopes for an interest rate cut by the Federal Resert protection costs lower. The main index of investment-grade credit default retraced some early tightening but was still about 1.75 basis points tighter on the day at about 76 basis points, according to Markit Intraday. Fed Chairman Ben Bernanke on Thursday said financial strains had dimmed the outlook for the US economy, signalling an openness to cutting interest rates again.
Credit default swaps on mortgage-related bonds tightened sharply following reports that a plan to stem subprime defaults could be announced as early as next Wednesday. The subprime plan was discussed by Treasury Secretary Henry Paulson at a meeting with top banking regulators and industry representatives on Thursday, sources familiar with the meeting told Reuters.
The cost of protecting Washington Mutual's debt with credit default swaps fell by about 52 basis points to about 321 basis points, or $321,000 a year for five years to protect $10 million of debt, according to Markit Intraday.
Home builder Toll Brothers' credit protection costs fell about 22 basis points to about 270 basis points, according to Markit Intraday. The cost to insure the home loan unit of Countrywide Financial Corp fell by about 3 percent to about 10 percent the amount insured, plus annual payments of 5 percent a year for five years, according to Phoenix Partners data. The swaps are trading at an upfront cost, which indicates perceived distress.
Issuers took advantage of improved sentiment to sell bonds, though new deals were being priced with hefty yield spreads. Wachovia Bank sold $2.5 billion of 30-year subordinated bank notes at a spread of 220 basis points over Treasuries, more than double the 97 basis points it paid on similar notes in January.
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