European credit spreads held up well on Friday despite a scare from Northern Rock which was forced to use emergency funding from the Bank of England, ahead of several events next week that will be crucial for market sentiment.
Five-year credit default swaps on British mortgage lender Northern Rock were 15 basis points wider at 145 basis points in afternoon trade, having fluctuated wildly in the session between 135 and 210 basis points.
Northern Rock, which has lent aggressively to home buyers, became the latest British casualty of a global financial crisis sparked by US mortgage defaults and a short term funding squeeze in the commercial paper market.
As customers queued to withdraw savings from Northern Rock branches, the British Bankers' Association reassured that it was a "sound and safe bank" and that there was "absolutely no reason for either mortgage customers or savers to worry."
The broader credit market also proved resilient in relatively quiet trading even as European stocks markets fell. Events next week, however, may help set sentiment for the near term as the US Federal Reserve meets to discuss interest rates, US investment banks report earnings and credit derivative indexes roll over.
The Fed meets late on Tuesday and is widely expected to cut rates by at least 25 basis points - from 5.25 percent now - and possibly more to help give financial markets a boost.
Describing next week as "probably the hottest week in Autumn", Unicredit (HVB) credit strategist Jochen Felsenheimer said the ideal case would be for the Fed to cut rates and to provide the market with a statement that does not ignore the severity of the crisis. "This will pave the way for the US investment banks to recreate full transparency by disclosing their exposure and the sensitivity of their business to current risk factors," he said.
By 1455 GMT, the iTraxx Crossover index, closely watched as a barometer of European credit risk sentiment and made up of 50 mostly "junk"-rated credits, was 7 basis points tighter at 329 basis points, a trader said. The investment-grade iTraxx Europe was at 47 basis points, 1.5 basis points tighter. Some strategists said short positions have been squared this week ahead of the iTraxx index rolls next Thursday, lending some support to spreads.
On the data front on Friday, US retail sales edged up in August but posted the biggest decline in almost a year when car sales were stripped out, while a key US consumer sentiment index rose slightly more than expected in September. Sels at Dresdner said that there was scope for some disappoint if the Fed does not deliver a 50 basis points next week.
Sentiment may also hinge on a slew of US investment bank third-quarter earnings scheduled, he said, starting with Lehman Brothers on Tuesday, as the financial sector and liquidity problems remain the key concern among investors. Morgan Stanley also reports on Wednesday, followed by Bear Stearns and Goldman Sachs on Thursday.
Then there is the huge load of commercial paper refinancing that must get done. So far, the $100 billion-plus of debt maturing in the next week has been relatively panic-free but potential negative headlines still pose risks. Others played down the emphasis that has been put on the commercial paper market.
"There are large volumes every week, every day. It's simply a constant, the amount of money that has to get rolled, but because it is such a big number people are worried about it" said Sels.