Credit spreads widen on oil, earnings fears

European credit spreads widened on Wednesday, tracking falls in equities, with concerns growing about corporate profits as oil prices surged to a new record. By 1533 GMT, the Markit iTraxx Crossover index, made up of 50 mostly "junk"-rated credits, was at 433 basis points, according to data from Markit, 20 basis points wider than late on Tuesday.
The investment-grade Markit iTraxx Europe index was at 75 basis points, 4 basis points wider. "We've rallied for six or seven weeks, and now we've settled back into the idea that we have to go wider," a trader said. "The speed of the sell-off in the equity markets has spooked people, and oil is not helping."
Oil prices surged more than $3 to a record above $132 after weekly US data revealed a larger-than-expected drop in US crude oil inventories. "The two main worries at the moment are oil and inflation," said Andrea Cicione, a credit strategist at BNP Paribas.
"Margins are being squeezed as companies struggle to pass on the rise in input costs to consumers, and revenues are also falling, so we should expect a slowdown in earnings going forward." One of the sectors most at risk was retailers, said Cicione, with evidence already growing that consumers are cutting back. Marks & Spencer, for example, failed to meet internal targets and said on Tuesday a slowdown in consumer spending could run until autumn 2009.
Elsewhere, ratings agency Moody's Investors Service was under fire after a report in the Financial Times said a computer coding error led the rating agency to assign incorrect triple-A ratings to a complex debt product. Moody's said in a statement it was conducting a "thorough review of this matter". A Moody's spokesman would not comment on the report beyond the statement.
The FT said internal Moody's documents it had seen showed that ratings on so-called constant proportion debt obligations (CPDOs) should have been up to four notches lower, and that the agency had discovered the error in its models early in 2007. Moody's shares sank almost 13 percent.
"For the ratings agencies this is a serious hit," said Cicione. "The FT is reporting that some people in the firm have known about the problem since early 2007. Clearly the deals should have been lowered."