Credit Markets Update: Negative equity sentiment transmutes into wider spreads

European credit default swap spreads were wider this week, with investors buying protection as credit concerns and accounting scandals in the US contributed to negative investor sentiment that led to a further battering of stocks.

“The massive slump in shares in Ford and General Motors on Thursday pumped the market with another injection of negative sentiment that pushed spreads wider,” said one London-based credit derivatives trader.

Banc of America Securities downgraded General Motors (GM) and Ford stock on Wednesday, saying they would be forced to follow DaimlerChrysler’s offer of longer warranties for their cars. Questions have also been raised about how GM and Ford would cover growing liabilities for pensions and health-care costs, said the trader.

Credit protection spreads on European autos were 10 basis points wider yesterday morning, and widened another 5-10bp as the US markets opened. Five-year credit protection on both General Motors and Ford Credit widened 25bp yesterday, and were trading at 255bp-mid and 205bp-mid today. Credit default swaps on DaimlerChrysler widened 15bp to 145bp-mid.

Credit default swaps on European industrials and utilities widened 2-7bp yesterday. “Trading is thin, but the prices are jumping all over the place,” the trader said.

Telecoms default swaps were highly traded in a volatile market, with swaps ending 5-15bp wider yesterday across the sector. Vodafone and Telefonica debt protection saw the biggest movement, with five-year credit protection trading as high as 195bp and 185bp, both up from 170bp-mid.

Roger Applegard, a telecoms analyst at ABN Amro in London, argued the recent widening of bonds and credit default swaps on Vodafone is overdone, and reflects fears over funding of potential acquisitions and apparently unfounded rumours over accounting irregularities.

“The market is pouncing on every piece of bad news and rumour, it’s a volatile time, especially for weak credits,” said another London-based trader.

A Commerzbank Securities report this week claimed the recent widening in protection for European banks and financials was also due to negative market sentiment, such as headline news, evidence of potential asset quality deterioration, and general market volatility, which is outweighing fundamentals. Pressure from the equity markets pushed spreads wider by 2-6bp for bank protection yesterday.

According to Commerzbank analysts Beate Munstermann and Ian Centis, in the near-term, spreads will likely be affected by heightened risk aversion and negative sentiment, but overall the market is very illiquid.

Brynn Lewis, a senior flow trader in financials at JP Morgan in London, agreed. “When the markets lose sight of the fundamentals and become sentiment driven, we see news stories having a larger than expected impact on spreads and an increase in correlation between credit spreads (bonds and CDS) and stock markets. This brings us opportunities but also unwanted illogical price action,” he said.