European credit spreads were tighter late on Friday, but trading volumes were thin, with US inflation taking centre stage along with Citigroup after it said it was bailing out its structured investment vehicles. Citigroup said it was rescuing $49 billion of troubled SIVs, prompting Moody's Investors Service to downgrade its credit rating by one notch to Aa3.
On the data front, US consumer prices jumped a bigger-than-expected 0.8 percent in November, the sharpest climb in more than two years, raising worries that inflation risks will limit the scope for further US rate cuts. "The data was negative but the market hasn't absorbed it. There is very little going on, it's very thin," a trader said.
By 1605 GMT, the iTraxx Crossover index, made up of 50 mostly "junk"-rated credits, was five basis points tighter at 336 basis points, according to data from Markit. The investment-grade iTraxx Europe was down at 50.75 basis points.
Moody's also cut Bradford & Bingley's ratings on concerns over lending concentrations and access to funding, which sent the cost of insuring its debt against default higher. Five-year credit default swaps on Bradford & Bingley rose 30 basis points to 160 basis points after the announcement.
UBS credit strategists said a range of positive news - ranging from the co-ordinated action of central banks to the gradual cleaning up of SIVs - have contributed to reducing the risk of another major shock to the financial market.
"They don't solve the existing issues though," said Geraud Charpin in a note. "Now that SIV assets are making their way to banks' balance sheets, these banks will need to fund them. They will also need to be transparent about valuations, marking down what needs to be marked down and recapitalise if needed."
The focus will hold on financials at least over the next weeks with fourth-quarter earnings due from Bear Stearns, Goldman Sachs and Morgan Stanley due over the next few days. "Fourth-quarter results will be important for setting out greater clarity on where we stand," said David Brickman, a credit strategist at Lehman Brothers at a press briefing.
"But it will not be the final word on the subject (of writedowns). It is not a question that we see the fourth-quarter numbers and then everything will get better, but of course it's significant."
What is certain is that banks will have to start raising capital. That likely boost in bond supply will present a buying opportunity for investors as banks offer large premiums to raise money, he said. The trader said the introduction of on-the-run single name contracts would also be in focus next week.
"There is the single name rollovers although there shouldn't be too much in that. Then there are bank earnings. People might also start to look at the inflation data we have just had a bit more seriously," the trader said.