European corporate bonds and credit default swaps rallied on Wednesday, as dealers covered short positions before Thursday's US interest rate decision, and investors snapped up bonds made cheaper by recent price falls.
Traders said many market-makers had built up short positions in corporate credit risk - meaning they had sold bonds or bought credit default swaps - and were looking to move back towards a neutral stance ahead of the rate decision by US Federal Reserve's Open Market Committee (FOMC).
The Fed's policy-makers are widely expected to raise the overnight federal funds rate by 0.25 percentage points to 5.25 percent, marking a 17th straight increase in the benchmark lending rate.
But many in the credit markets worry new Fed Chairman Ben Bernanke could choke off growth in the world's largest economy by raising rates too far or too fast, and so every nuance of Thursday's decision will be scrutinised.
"There's a bit of a short-covering rally ahead of the FOMC tomorrow," said one credit trader in London. "There are quite a lot of shorts in the market at the moment, in the dealer community, so they're all looking to book a bit of profit and take some risk off."
The iTraxx Crossover index, composed mainly of "junk"-rated credit default swaps, tightened 10 basis points to be bid at 293 basis points, a second trader said, while the iTraxx Europe index of 125 key investment-grade default swaps tightened 1 basis point to be bid at 33 basis points.
"There's a much better tone," the second trader said. "Real money (investors) have been relatively sidelined but now some of them are stepping in and taking advantage of bonds at these cheaper levels."
In the telecoms sector, one of the market's biggest, spreads on longer-dated bonds narrowed by 3 to 4 basis points, the first trader said.
The spread on Telecom Italia's 2055 bond narrowed 3 basis points to be bid at 221 basis points over government debt, while the spread on Deutsche Telekom's 2033 bond tightened by a similar amount to be bid at 147 basis points over government debt.
Corporate hybrid bonds - higher-yielding bonds which carry some of the risks associated with shares - rallied after stumbling badly earlier this month, a third trader said.
The spreads on hybrid bonds from Solvay and Henkel both tightened about 15 basis points, to be bid at 235 and 290 basis points over equivalent government debt, he said.
Utility bonds rallied too, with the spread on Veolia's 2033 euro bond contracting 6 basis points, to be bid at 134 basis points over equivalent German government Bunds.
In the primary market, French insurer AXA set guidance on a three-part hybrid bond to help refinance its $10.9 billion purchase of Winterthur, an official at one of the banks managing the sale said.
AXA plans to sell a sterling perpetual bond callable in 2016 with a spread of about 190 basis points over UK gilts, and a sterling perpetual bond callable in 2026 that will yield 15 to 20 basis points more than the first bond, the official said.
It also plans to sell a perpetual euro bond callable in 2016 yielding "high 150s to 160" basis points over mid-swaps.