European credit spreads narrowed on Friday after US Treasury Secretary Henry Paulson said his chief aim was to support mortgage finance companies Fannie Mae and Freddie Mac in their current form. By 1515 GMT, the Markit investment-grade iTraxx Europe index was at 103 basis points, according to Markit data, 2 basis points tighter versus late on Thursday.
The iTraxx Crossover index, made up of 50 mostly "junk"-rated credits, was 3.25 basis points narrower at 541.75 basis points. By contrast, US and European equity markets fell steeply, with the FTSEurofirst 300 down 2.4 percent by 1523 GMT.
"The US government has made it quite clear that they will not allow anything to interfere with the smooth running of the US economy. A bankruptcy of the two largest mortgage entities in the US is just not a feasible option," a trader said.
Worries about Fannie and Freddie grew after the New York Times said the US government was considering a plan to place Fannie and Freddie, which own or guarantee nearly half of all US mortgages, into conservatorship. This means shares in the companies would be worth little or nothing, with taxpayers obligated to cover any losses on their home loans.
Shares in Fannie and Freddie plummeted by around 30 percent, but credit default swaps on both companies tightened and their bonds rose. "The more their equity gets blown out, the more they get to the point where the US will underwrite them," the trader said. More broadly, the trader added that debt markets were already largely pricing in recession fears, and that little could unnerve them more.
"Banks are under pressure, financial markets are not working properly, we're about to slide into a global recession, earnings are going to get crushed, equities are overvalued, consumer sentiment numbers were rubbish, (and) everyone knows it," he said.