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Risk appetite returns to US corporate CDS markets

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US corporate credit default swap markets, while trading in a broader range, were little changed over the course of February 2010, according to a report by GFI Group.

While rising concerns of potential default in certain European sovereign contracts initially weighed on credit sentiment across the globe, risk appetite returned as expectations of sovereign default – or certainly concerns over the impact of contagion from a sovereign credit event – receded.
While, at a sector level, only the materials group was worthy of mention over the course of the month, greater attention was paid to corporate-specific events, such as quarterly earnings and/or corporate activity. This marks something of a change from recent CDS market activity, where macro themes and sector rotation had appeared to be the predominant drivers of changing credit risk.
Among the materials group GFI saw a pronounced move wider in many of the more actively traded contracts, perhaps highlighting residual fears over the ongoing strength of global economic growth and, in particular, in emerging market growth.
Elsewhere, quarterly earnings were a big driver of corporate credit markets, with names such as H&R Block and Ryder System responding particularly poorly to weaker-than-anticipated corporate financial performance.

February also saw a more pronounced return to corporate activity in US markets, with several high profile deals announced throughout the course of the month. Air Products & Chemicals five-year CDS moved around 70 per cent wider during the course of the month in response to the company’s USD60.00/share cash offer for US peer Airgas.

GFI expects CDS markets to remain particularly sensitive to M&A activity, especially in cases where the capital structure is significantly impacted, should this re-emerge as a predominant market theme.
European corporate credit markets were wider over the month, with sovereign risk hogging the spotlight again. Sovereign concerns reached their peak early on in the month, before more bullish sentiment took over as corporate earnings proved resilient, dragging the iTraxx from 94bps wide to 83bps. Poor consumer and industrial sentiment figures pushed credit wider again in the final week of the month.

Economic concerns led banks, autos and capital goods aggressively wider, whilst defensive sectors, such as food, beverage & tobacco and pharmaceuticals were the most stable.
As in the US, European earnings proved a big driver of individual credits, with strong performances from the brewers, particularly Heineken and Carlsberg, helping to keep risk on a tightening footing. Their more global diversified business profiles compared with many European companies provides a boon as their domestic region comes under pressure.
Elsewhere, poor numbers from Thales drove the entire CDS curve sharply wider. The company’s announcement that it was cutting its dividend by more than half did little to assuage creditors’ concerns.
More consistent with trading in the US than in Europe, Asian corporate CDS markets were little changed throughout February. While a modest widening bias was in evidence, GFI says this can largely be attributed to company-specific concerns in only a handful of contracts, with the majority of these in Japan.

Activity remained heavily focused in the historically more liquid Japanese blue-chip contracts, with the bulk of volume in the region attracted to this area of the market.
Mitsubishi Electric, Nippon Telegraph & Telephone and Takashimaya saw the most pronounced widening throughout the course of the month, wider by 51.9 per cent, 40.3 per cent and 34.0 per cent respectively.
European sovereign risk remained the focus of credit markets in February with shifting sentiment and rhetoric regarding the likelihood of Greece defaulting and the potential for an EU bailout determining the direction of risk. Concerns that, no matter the final outcome, the EU will be a weaker economy as a result of Greece’s precarious financial position drove the Euro to its weakest level versus the US dollar since May 2009, whilst Germany saw its sovereign CDS lead the region wider, out nearly 30 per cent on the month.

Fitch cut its credit rating on the major Greek banks; whilst all the agencies talked about the possibility of further rating cuts of the sovereign debt. Strikes and mass demonstrations in Athens greeted EU financial inspectors who harbour some scepticism that the Greek government will be able to cut the four percentage points off its budget deficit this year, as was mandated in the most recent Brussels summit of EU leaders.
Elsewhere, sovereign risk was more stable, with spreads generally narrower in LatAm – led by Mexico and Brazil – and Asia – led by China. There were other pockets of concern, namely in Dubai and Argentina. Dubai’s sovereign CDS pushed back to the levels reached in November 2009 as talks on the restructuring of Dubai World debt have so far proved unproductive.

The Argentine CDS traded above the 900-1100bps range it had been in since last September’s narrowing, printing as wide as 1200bps late in the month. Investors are becoming increasingly concerned over the nation’s lack of confidence in the Argentine government, whilst President Cristina Fernandez de Kirchner’s decree to tap USD6.6bn in central bank reserves to pay debt due this year is stalling in the courts.

GFI Group is a provider of wholesale brokerage, electronic execution and trading support products for financial markets.

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