The cost of insuring the debt of broadcaster ProSiebenSat.1 jumped on Friday following a ratings downgrade, while the broader European credit market widened slightly in choppy trading. In index trading, the iTraxx Crossover, made up of 50 mostly "junk"-rated credits, was 3 basis points wider at 227 basis points by 1400 GMT, a trader said, having traded in a range of 224 to 234 basis points throughout the session.
"I think there is this fear of whiplash, where people have bought protection and this worry that things might suddenly tighten in their faces," he said. "There's also the worry about subprime and that some people may have to mark their books down substantially as it's the end of the quarter."
Volatility may increase next week thanks to an expected lack of liquidity ahead of the Independence Day holiday in the United States on Wednesday. "We could drift a little tighter, particularly in low-beta names, but the more volatile and high-beta credits are a worry," the trader said.
In a signal that this month's correction may be more serious than a similar surge in spreads back in February, single name CDS have moved higher in line with the index, another trader said.
That suggests deeper underlying problems within credit markets have surfaced after the near collapse of two Bear Stearns hedge funds that had made bets on risky US mortgages. It's a theme that is likely to keep running for some time yet. "Additional weakness in the credit markets over the next few weeks is inevitable on the back of subprime-related liquidations by hedge funds and further hedge fund closures," wrote Robert McAdie, a strategist at Barclays Capital in a note.
"However, given the support provided by positive fundamentals, we would not expect the volatility to persist beyond the short term." The outlook for economic growth has certainly proved more rosy than many had thought at the start of the year as previous expectations fade of a US Federal Reserve rate cut this year. Most now expect US rates to stay on hold.
On the data front next week, US non-farm payrolls for June on Friday will help shed more light on how employment is faring in the United States, while the Bank of England is expected to raise rates to 5.75 percent on Thursday.
Five-year credit default swaps on ProSieben shot 25 basis points wider to 192.5 basis points by 1400 GMT following a four-notch downgrade to "junk" status by Fitch ratings, the second trader said.
The reason for the downgrade, to BB- from BBB, was ProSieben's 3.3 billion euro ($4.4 billion) acquisition of rival SBS Broadcasting, which Fitch said would "radically modify PSS1's credit profile". Elsewhere in the spotlight was French car parts maker Valeo, which was 10 basis points tighter at 68 basis points by 1430 GMT.
It had rallied by 18 basis points after the Financial Times said the company had failed to agree on a leveraged buyout with private equity group PAI. Its CDS then pared some of those gains after the company said it would continue talks over the weekend, keeping worries about a buyout alive.
In the cash bond market, the FTSE Euro Corporate Bond Index showed investment-grade corporate bonds in euros yielding an average 44.4 basis points more than similarly dated government bonds at 1450 GMT, 0.2 basis points up on the day.