iTraxx rally indicates improved debt market sentiment

The thinning of spreads on the European market for credit default swaps, the iTraxx crossover index, points to increased optimism in the debt markets.

The market for credit default swaps rallied yesterday on the lack of bad news in the markets in the last few days.

The iTraxx Crossover index, a key indicator of market sentiment, has rallied to 320 basis points today. 

“The 5y iTraxx Crossover index made an historic wide of 500bp on intraday trading on Monday 30th July. Since then it has rallied back to 320bp today as investors have cut shorts. The index has been highly volatile and sentiment driven in the last few weeks and a few bad headlines could easily see this turn on its head again,” said Michael Hampden-Turner, director, Citi.

Credit default swaps allow investors to take a view of the creditworthiness of a company or a group of companies. The iTraxx is regarded as a good indicator of sentiment because investors can go short and they can go long on investments, taking a view on their overall credit performance. This enables investors to hedge bond portfolios against credit spread widening.  

“The iTraxx Crossover index is a bell-wether for European high-yield credit because of its depth and liquidity. So if the 5y Crossover index broke 500bp again, this would worry me if I were a private equity executive as it indirectly threatens leveraged buy-outs as it is symptomatic of a market aversion to high-yield debt,” said Panikos Teklos, vice president, Citi.

Headlines have been more positive in the last week and so the index has staged a recovery. But it is likely there will be further bad sub-prime and hedge fund stories because valuations for July will be coming out and so the market may not stay so low. It is widely believed investors in the debt markets will only return in force after the holiday season ends.