July 24 (Bloomberg) -- Corporate credit in the U.S. and Europe rallied this week to levels last seen more than a year ago as company earnings beat estimates at a record pace.
Yields on investment-grade bonds fell relative to benchmark rates to the lowest since August and half their level in March, while the riskiest bonds are trading at the highest prices since Lehman Brothers Holdings Inc. collapsed in September, according to Merrill Lynch & Co. index data. The cost to protect U.S. and European bonds from default dropped to a one-year low.
Credit markets worldwide are rallying for a fourth month as investors snap up the riskiest securities, reversing last year’s losses. The cost of protecting debt from default in the credit- swaps market has tumbled as traders bet higher-than-forecast profits will help companies meet their commitments.
“Just about every company is beating on the bottom line,” said Rajeev Shah, a London-based credit strategist at BNP Paribas SA.
About 75 percent of the 204 Standard & Poor’s 500 companies that have posted second-quarter earnings exceeded forecasts, bolstering optimism the recession is over, according to data compiled by Bloomberg.
Demand for high-risk, high-yield or junk assets has returned after the market was effectively shut for more than a year as investors shunned all but the safest securities. High- yield bond spreads narrowed 53 basis points this week to 988 basis points yesterday, falling below “distressed” levels for the first time since Sept. 25, Merrill data show.
Debt with spreads of 10 percentage points or more is considered distressed. A basis point is 0.01 percentage point.
Fiat’s Junk Bonds
“This year’s persistently strong returns in high-yield bonds are without precedent,” Martin Fridson, chief executive officer of Fridson Investment Advisors in New York, wrote in an e-mail to clients today. “Issuers that were on the brink of insolvency benefited the most from the reopening of the capital markets.”
Fiat SpA’s new 1.25 billion euros ($1.78 billion) of junk bonds jumped almost 3 percent when they started trading today. The yield premium over similar-maturity government debt dropped 162 basis points from the issue spread, Royal Bank of Scotland Group Plc prices on Bloomberg show.
High-yield bonds are rated below Baa3 by Moody’s Investors Service and BBB- by Standard & Poor’s.
Bonds rated CCC or less, the riskiest debt, are trading at an average price of about 69 cents on the dollar, the highest since Lehman filed for bankruptcy Sept. 15, Merrill data show.
‘V-Shaped Scenario’
“The lowest-quality category of high-yield bonds is pricing in a recovery scenario as optimistic as any V-shaped scenario could be,” Bank of America Corp. strategists Oleg Melentyev and Mike Cho in New York said yesterday in a report. “Unless this credit cycle is fully in the rear view mirror, this level has no historical precedence.”
The extra yield investors demand to own U.S. investment- grade bonds rather than Treasuries fell to 302 basis points yesterday, the lowest since Aug. 11, down from 600 basis points on March 13, Merrill index data show. Spreads on bonds issued by European companies have narrowed 215 basis points to 248 basis points from a high of 463 basis points in March.
Credit-default swaps on the Market CDX North America Investment-Grade Index, linked to 125 companies in the U.S. and Canada, declined 10.5 basis points this week to a mid-price of 118 basis points, the lowest since June 19, 2008, according to CMA Data Vision.
The Markit iBoxx European Corporate index, which includes bonds sold by Vodafone Plc, Rolls Royce Plc and Deutsche Bank AG rose as much as 60 basis points this week to 87.98, the highest since Sept. 9. Benchmark credit risk indexes fell close to a one-year low.
Credit-default swaps pay the buyer face value if a borrower defaults in exchange for the underlying securities or the cash equivalent. A basis point is equivalent to $1,000 a year on a contract protecting $10 million of debt.
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