The cost of credit protection on German steel firm Thyssenkrupp rose on Wednesday amid speculation it may bid for Britain's Corus, raising the chance of its credit rating dropping to junk.
Bonds of telecommunications firms gained as investors switched money out of oil-sensitive auto bonds, after the price of crude hit a new record above $51 a barrel.
Credit default swaps on steel-giant Thyssenkrupp rose around 15 basis points in early trade then settled at around 77 basis points, up five basis points. That means it costs 77,000 euros annually to insure 10 million euros of Thyssenkrupp debt.
Corus's 2011 euro bond, sold in September, rose around one point to 105.5 percent of face value. Credit default swaps on the company fell 20 basis points to 242 basis points.
Ulrich Middelmann, head of Thyssenkrupp's steel division, said that the German firm has raised the possibility of a merger with Corus, according to a report in the Financial Times. Any such deal would damage the company's credit quality, since Corus's ratings are lower.
"A merger with Corus would most likely be ratings negative" for Thyssenkrupp, said Dresdner Kleinwort Wasserstein analysts in a note, even though the Anglo-Dutch group improved its performance in the first half of the year.
Thyssenkrupp is rated at the bottom of the investment-grade category by both Moody's Investors Service and Fitch Ratings. It is rated BB by Standard & Poor's, two notches below investment-grade.
Corus however is rated firmly in the speculative-grade category, with its latest issue of notes rated B3 by Moody's, six notches below investment grade, and an equivalent B- by Standard & Poor's.
A move to "junk" ratings from investment-grade would force some bondholders to sell Thyssenkrupp debt, since they cannot hold non-investment-grade paper, and push the company's financing costs higher.
"The article at this stage is speculation, and given Thyssen statements, it very much remains to be seen how seriously it is considering such a transaction," Dresdner said.
In the wider market, the FTSE Euro Corporate Bond Index showed investment-grade corporate bonds in euros yielding an average 46.4 basis points more than similarly dated government bonds at 1430 GMT, 0.3 basis points more on the day.
"Telecommunications bonds have outperformed with longer-dated maturities faring best," said one trader. "Otherwise it's pretty quiet - spreads gapped out this morning but have come in again this afternoon."
The spread on France Telecom's 8.125 percent bond due in January 2033, one of the most liquid in the sector, tightened around 2 basis points to 105 basis points over government bonds, the trader said.