Investors keep appetite for risk

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The cost of insuring a bond against a default has fallen sharply in recent days in Europe’s derivatives markets, suggesting that the mood in some corners of the debt world remains relatively benign.

The move may have been exaggerated by a forthcoming technical change to the index, analysts say. However, it may also show that investors remain relatively willing to tolerate risk – irrespective of widespread predictions about a forthcoming turn in the credit cycle.

These signals of investor sentiment are likely to be closely watched, given that a host of major companies are expected to issue bonds in the coming weeks, after the recent summer lull.

Until recently, the main measure used to gauge investor sentiment in the credit market was the secondary price of cash bonds. However, in the past couple of years many investors have started to focus on the price of credit default swaps – an instrument that lets investors place bets on the chance of default. That is because the CDS market has recently become considerably more liquid than the market for cash bonds.

One important CDS indicator now being tracked is the so-called “crossover” part of the Itraxx series – or a basket of CDS prices for European companies which are at the cusp of investment grade and sub-investment grade ratings.

A few weeks ago, the average price of this index was well over 280 basis points (meaning that the cost of insuring €10m of bonds against default was more than €280,000 year). However, on Monday the index closed at 232bp, 6bp down on the day – and back towards the levels seen earlier this year, when credit conditions were extremely benign.

The swing has surprised some observers, given that the European Central Bank has been raising interest rates, and given widespread expectations that investors would become more risk-averse this autumn.

Some analysts blame it on the forthcoming “roll” of the Itraxx series on September 20 – a technical event that occurs twice a year when the baskets are updated. Other observers argue that there is currently some heavy trading by hedge funds or other large players.

However, some analysts have concluded that the Itraxx index shows that investors remain very upbeat, irrespective of earlier gloomier predictions. Separate surveys by JPMorgan and Citigroup on Monday suggested the mood in the credit markets will remain benign in the coming weeks.

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