European credit markets volatile

European credit markets were volatile on Thursday, spooked by worries about troubled hedge funds linked to the risky US subprime mortgage sector. The Crossover index, made up of 50 mostly "junk"-rated credits, traded 10 basis points wider at 210 basis points at 1420 GMT, but had jumped as high as 216 basis points earlier on Thursday.
At the centre of investor concern was the US subprime mortgage sector, after several Wall Street banks unwound positions in two Bear Stearns hedge funds heavily invested in the riskiest US home loans. "We're close to a level where if it holds somewhere between 210-215, we'll probably have a big rally. But if we don't there may be something more serious going on in the world of credit," said a trader in London.
"The problem is we won't get any clarity about the real implications of the subprime market for a long time, so it's very much about sentiment. An information vacuum just enhances the volatility," he added. That nervous sentiment follows recent jitters about higher interest rates and a spike in US benchmark 10-year Treasury yields earlier this month to five-year highs around 5.30 percent.
The iTraxx index has see-sawed in the last couple of weeks as a result. It pushed wide, close to 220 basis points two weeks ago, amid concerns that higher rates might hurt corporate profits. But it then recovered to trade below the key 200 mark late last week.
Some strategists said that for now, at least, the spike in European credit market spreads may be a temporary correction. "Short term, European spreads may have overreacted a little bit," said Jim Reid, a credit strategist at Deutsche Bank in London.
Looking further ahead, however, he said weakness in the US housing market was yet to hit a bottom and predicted "further stresses to come" for European markets. "The main basis for us being underweight credit is probably the US housing market and the unknown about what will actually happen in terms of where a lot of the losses in the subprime market actually lay," he added.
Equity markets were also weaker. The FTSEurofirst 300 index of top European companies was down 1 percent at 1,604 points by 1440 GMT. The Dow Jones industrial average, meanwhile, was only 12 points lower at 13,475 points, a day after the Standard & Poor's biggest drop in two weeks on Wednesday. The trader said the whole market was wider, with no significant standouts among single-name credit default swaps.
"We've seen ABX in the US underperform which has had a bit of a knock-on effect in the loan market. Anywhere that has a bit more leverage in the system is suffering," he said.
The ABX derivatives index dropped to a new low on Thursday, with ABX 2007-1 "BBB-minus" - referencing home loans made to risky borrowers in the second half of last year - sliding to 58.25 bid, according to fund managers, versus a close at 59.79 bid on Wednesday. The ABX index has dropped about 40 percent since January.
The primary market was quiet after a rush of new issuance at the start of the week from the likes of telecoms network firm Ericsson, although Arcelor Finance is roadshowing on Thursday and Friday for its planned two-part euro benchmark bond. In the cash bond market, the FTSE Euro Corporate Bond Index showed investment-grade corporate bonds in euros yielding an average 41.5 basis points more than similarly dated government bonds at 1510 GMT, 0.2 basis points up on the day.