Prices on the Upswing for Corporate Credit Swaps

This week's sharp rise in a credit default swaps benchmark indicates a plunge in investor confidence in corporate debt.

A gauge of U.S. corporate credit risk rose for a third day, reaching the highest in six months, as concern mounts that the Federal Reserve will start scaling back record bond-buying that has bolstered debt markets.

The Markit CDX North American Investment Grade Index, a credit-default swaps benchmark that investors use to hedge against losses or to speculate on creditworthiness, increased 1.8 basis points to a mid-price of 94.9 basis points at 12:34 p.m. in New York, according to prices compiled by Bloomberg. The gauge, trading at the highest level since December, has surged 10.8 basis points since June 14, heading for its biggest weekly increase since May 2012, excluding rolls into new series.

Investors’ confidence in corporate debt has plunged since Fed Chairman Ben S. Bernanke said June 19 that the central bank may pare $85 billion of monthly bond purchases this year and end it in mid-2014 if the economy achieves the Fed’s objectives. The Fed’s stimulus measures, known as quantitative easing, have suppressed interest rates, pushing investors into riskier assets such as corporate bonds in search of higher yields.

“In a brief period of time you’ve put a lot of strain on the markets,” William Larkin, a fixed-income portfolio manager who helps oversee $500 million at Cabot Money Management Inc., said in a telephone interview from Salem, Massachusetts. “If the Fed acts too early, it can really hurt.”

The credit-swaps index typically rises as investor confidence deteriorates and falls as it improves. The contracts pay the buyer face value if a borrower fails to meet its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.

Bernanke, speaking this week after a two-day meeting of the Federal Open Market Committee, said reducing bond purchases would depend on meeting the central bank’s employment and inflation thresholds. Policy makers will cut monthly bond purchases by $20 billion at the Sept. 17-18 FOMC meeting, according to 44 percent of economists in a Bloomberg survey.

The yield on 10-year Treasury notes climbed to 2.5 percent today for the first time since August 2011 and the Standard & Poor’s 500 Index fell for the third day, touching the lowest since April 26.

“You have to expect volatility as the Fed adjusts its profile on quantitative easing as they lead to a more normalized environment,” Morgan Stanley Chief Executive Officer James Gorman said today in an interview. “And that volatility and the Fed actions are a function of the economy recovering. And a recovering economy does a lot of good things for our businesses.”

The risk premium on the Markit CDX North American High Yield Index rose 2.4 basis points to 466.8 basis points.

The average relative yield on speculative-grade, or junk- rated, debt fell 0.5 basis point to 564.1, Bloomberg data show. High-yield, high-risk debt is rated below Baa3 by Moody’s Investors Service and less than BBB- at S&P.

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