European credit spreads moved in tandem with equities on Tuesday, tightening significantly in the morning and then losing some of those gains later in the day. By 1550 GMT, the iTraxx Crossover index, a closely watched barometer of European credit risk that is made up of 50 mostly "junk"-rated credits, was 5 basis points tighter on the day at 114 basis points, a trader said.
The index had racked up an initial 10 basis points of tightening after the Dow Jones industrial average hit a record high overnight and European stocks surged, with the FTSEurofirst 300 index reaching its highest level since July 26. By 1550 GMT, however, US share indexes were lower and the FTSEurofirst 300 had trimmed its gains.
"The Crossover seems to be tracking stocks up and down," a trader said. "That's purely what it's about today." Stocks benefited on Monday partly from big write-downs announced by Citigroup and UBS, which were seen as being conservative and open in reporting their problems, as well as from a slowing in the ISM index of US manufacturing, which boosted hopes for interest rate cuts.
"Equities still seem to be the preferred asset class in the current environment, clearly indicating that investors anticipate that spillover effects from subprimemania onto the real economy will remain limited," wrote Jochen Felsenheimer, head of credit strategy at Unicredit (HVB) in a note to clients. "We think markets are currently undershooting the fundamentally fair equilibrium level for credit spreads," he added.
Northern Rock credit default swaps widened by 65 basis points to 200 basis points on fears the British mortgage bank could be broken up and sold off in pieces, not leaving enough to repay all Tier 1 capital and subordinated bonds, a second trader said.
"Its senior debt will get paid back," he said. CDS spreads on senior debt are widening, however, because investors have decided "to remove any exposure to Northern Rock, and the best way to do that is by buying protection in the CDS market".
CDS for DaimlerChrysler narrowed by 5 basis points to 29 basis points after Moody's Investors Service upgraded the carmaker's long-term debt ratings to A3 from Baa1 late on Monday. In the primary market, Czech electricity firm CEZ priced a five-year 500 million euro bond at mid-swaps plus 63 basis points, one of the banks managing the sale said.
Guidance was tightened from an initial level of mid-swaps plus 65 to 70 basis points, making the deal the latest in a string of bond sales that have been well received after the summer shutdown in the new issuance market came to an end.