The cost to protect against a default by U.S. banks rose and a benchmark gauge of corporate credit risk reached a 14-month high amid fear that Europe's debt crisis will infect the global financial system and sink the economy back into recession.
Credit-default swaps on Bank of America Corp., the nation's biggest lender, surged to the highest since April 2009 before paring the gain. The cost to protect against defaults by European financial companies reached a record, and a swaps index that gauges the perceived risk of owning junk bonds, which falls as sentiment deteriorates, is at about the lowest level in more than a year.
Investors are turning to the derivatives to protect against losses as European leaders struggle to contain a crisis of confidence that's sent borrowing costs for Spain and Italy to euro-region records and this week caused credit swaps on France to soar. Confidence in corporate credit deteriorated even as U.S. jobless claims fell and stocks soared.
"There's clearly a panic going on in the market," Andrew Feltus, a money manager at Pioneer Investment Management Inc. in Boston, said today in a radio interview on "Bloomberg Surveillance" with Ken Prewitt and Tom Keene, discussing junk bonds. "Prices are at such a point that you can even survive a recession, but people aren't looking at the fundamentals. They're just looking at the technicals, and 'get me out of here,'" said Feltus, who oversees the $2.1 billion Pioneer High Yield Fund.
Swaps on Charlotte, North Carolina-based Bank of America soared as much as 71 basis points to a mid-price of 375 basis points, according to broker Phoenix Partners Group. They fell back to a mid-price of 343 basis points as of 2:54 p.m. in New York.
The contracts have been pushed to the highest ever relative to its peers as investors speculate the bank will have to bolster capital as mortgage investors sue to force the lender to buy back faulty home loans.
Credit swaps on Goldman Sachs Group Inc. added 29 basis points to 224, and those on Citigroup Inc. climbed 24 basis points to 218 basis points, according to data provider CMA, which is owned by CME Group Inc. and compiles prices quoted by dealers in the privately negotiated market. Contracts on Morgan Stanley jumped 28 basis points to a mid-price of 285, Phoenix prices show.
"Concerns around the EU and risk in general seem to be dominating fundamentals at this point," said Joel Levington, a managing director of corporate credit at Brookfield Investment Management Inc. in New York.
Swaps on Societe Generale SA, the French bank whose shares have plunged 16.5 percent the past two days, jumped to a record high for the fourth straight day. The contracts rose 4.5 basis points to 341.5 as of 4:30 p.m. in London after earlier reaching at least 379, CMA prices show. Swaps on the French government fell from a record high reached yesterday, declining 4.8 basis points to 174.5 basis points, according to CMA.
Contracts on Dexia Credit Local SA, a unit of Dexia SA, Belgium's largest bank by assets, rose 32 basis points to a record 600 basis points, CMA prices show. Swaps on Belgium's debt, which rose to a record 270 basis points yesterday, fell back to 262 today.
The Markit iTraxx Financial Index, linked to the senior debt of 25 banks and insurers, jumped as much as 26 basis points to a record 257 before falling back to 241, JPMorgan Chase & Co. prices show.
Paris-based SocGen, France's second-biggest bank, is among banks being targeted by investors because of its perceived dependence on short-term funding, according to analysts at Royal Bank of Scotland Group Plc.
Banks' overnight borrowings from the European Central Bank jumped to the highest in three months today, a sign some lenders may have need for emergency cash. The gap between the three- month euro interbank offered rate and the overnight indexed swap rate widened to the most since April 2009, a sign that European banks are becoming increasingly reluctant to lend to each other for longer than overnight.
"It has the risk of creating a self-fulfilling prophecy," Andrew Sheets, head of European credit strategy at Morgan Stanley in London, said in a telephone interview. "Sovereign weakness creates the widening you see with banks, and that creates more concern about the financial system in said country, which causes sovereign spreads to widen further. There's been an inability to break that linkage."
Helping to temper concerns the U.S. economy is slowing, first-time applications for jobless benefits in the U.S. decreased 7,000 in the week ended Aug. 6 to 395,000, the fewest since April, the Labor Department said today in Washington.
High Yield Index
The Standard & Poor's 500 Index rose 5 percent to 1,177.12 at 3:07 p.m. in New York after tumbling 4.4 percent yesterday.
The Markit Group CDX North America High Yield Index, tied to the debt of 100 companies with below-investment grade ratings, rose 0.4 percentage point to 93.4 percent of face value as of 3:08 p.m. in New York. It earlier fell to as low as 90.9, the lowest since September 2009.
The index includes companies such as Texas power producer Energy Future Holdings Corp. and Clear Channel Communications Inc. that were acquired in leveraged buyouts before the credit crisis three years ago.
A broader gauge of U.S. corporate credit risk that gains as investor confidence deteriorates, climbed to the highest level since June 2010. The Markit CDX North America Investment Grade Index of credit-default swaps, which investors use to hedge against losses on corporate debt or to speculate on creditworthiness, added as much as 11.1 basis points to a mid- price of 126.5 basis points earlier today. The gauge was up 0.9 basis points to a mid price of 116.4 at 3:07 p.m. in New York.
Hedge Funds Traded
Credit swaps pay the buyer face value if a borrower fails to meets its obligations, less the value of the defaulted debt. A basis point equals $1,000 annually on a contract protecting $10 million of debt.
Investors have gravitated to the credit swaps market this week at about double the volumes from the previous month, data from London-based Markit Group Ltd. show.
Banks, hedge funds and other money managers traded 770 contracts on the benchmark investment-grade index yesterday, compared with an average of 445.6 the past month, the data show. A day earlier, 926 five-year index contracts were traded, according to Markit. Most of the trading is done in five year contracts.