Japan Credit Market Update: Spreads track equities on WorldCom fears

The cost of default protection on Japanese credits stabilised on Friday after Wednesday’s sharp widening caused by a $3.8 billion accounting scandal at US telecommunications group WorldCom, volatile equity markets and the steady strengthening of the yen against the US dollar, traders said.

Credit default swap spreads on Friday tightened back to levels where they traded earlier in the week after widening by about 10 basis points across the board.

“There was a lot of protection buying in the more liquid names like banks and consumer electronics on Wednesday,” said one trader.

Five-year credit protection on Fujitsu was quoted at a spread of about 110bp Friday, down from 120bp in the middle of the week and Toshiba’s five-year protection also tightened by about 10bp Friday to 145bp.However, despite Friday’s tightening, continued uncertainty kept swap spreads at levels higher than where they ended last week. Fujitsu was quoted last Friday around 94bp and Toshiba was quoted around 97bp.

The new case of accounting fraud, which could end in the collapse of WorldCom, sent shivers through the investor community and fears of another Enron-type bankruptcy generated increased risk aversion globally.

In Japan, the yen RiskGrade Volatility index, which measures the daily riskiness of market returns, rose to a 52-week high of 57 on Wednesday.

The initial equity sell-off that resulted from WorldCom rippled through to the Japanese credit default swap market, which traded “in line with equity markets,” the trader said. And as equity markets recovered, thanks to bottom fishing, Japan’s credit default swaps also recovered.

The Nikkei was at 10,501.61 in mid-session in Tokyo on Friday after slipping 4% to a four-month low, at 10,074.56, on Thursday. The Dow Jones Industrial Average closed at 9,269.92 Thursday, after dropping to 9,021.67 at mid-session on Wednesday.

To make things worse for the Japanese market, another trader reckoned that the cost of default protection on Japanese corporates has also appreciated because of concerns that the strong yen will have an adverse effect on Japanese exporters. The dollar has been on a downward slope since the beginning of the year. It is currently trading around ¥119.50, after reaching the ¥135.00 level earlier this year.