American credit market outlook

The credit spreads of Tyco Inc may have already hit their lowest levels of the year on the combination of a ratings upgrade and its pledge Thursday to retire debt, but traders said more improvement may be on the way.
While profit-taking may rule in the short term, pushing those spreads wider, Tyco is poised to receive a ratings upgrade from Moody's Investors Service on the horizon that would take the company back to investment-grade territory.
On Wednesday it was Standard & Poor's that upgraded Tyco to "triple-B," two notches above junk, citing the conglomerate's "substantial recent and prospective improvement" in its debt profile, leverage, free cash flow and access to capital markets.
Of the major credit ratings agencies, only Moody's ranks Tyco in sub-investment grade territory - but for that reason many investors are prevented from touching the company's debt or credit derivatives.
Once that changes, Tyco is likely to be included on major investment-grade credit indexes and its credit spreads will compress even more, traders said.
In a sign of how debt-laden companies are still reversing the 1990s binge and reducing leverage, Tyco said on Thursday it would use the large amounts of free cash flow it is currently generating to cut down the bulk of its nearly $18 billion of debt over the next several quarters.
Tyco, which has $3 billion of cash on hand, said it plans to maintain a cash balance at least $2 billion while trimming its debt and making contributions to its underfunded pension.
The news helped Tyco's five-year spread in the credit default swaps market shrink about 4 basis points to trade around 66 basis points, which means it would cost roughly $66,000 a year for $10 million of default protection on the company's debt. That is down from around 90 basis points at the start of the year.
But 10-year default protection on Tyco trades around 90 basis points, traders said, a relatively high spread relative to five-year protection given the company's improving financial profile and ratings upgrades. Some expected 10-year protection costs to fall as well in coming weeks.
With an investment-grade rating from Moody's, traders said Tyco's five-year spread could in the mid-50s.
Moody's rates Tyco at "Ba2" - a full two notches below investment-grade, and said in late-April it may soon upgrade the company. Earlier this month Fitch ratings lifted Tyco's rating to investment-grade from junk.