Economic Angst Sparks Surge In Insurance Against Bond Defaults

In the wake of rising concerns about the U.S. economy and European consumer spending, debt investors are increasingly resorting to insurance against corporate bond defaults.

What Happened: The cost of insuring a group of North American high-grade credits against default experienced a significant increase on Friday, the largest since October.

The credit default swap index recorded its highest daily trading volumes in roughly five months. Its European equivalent also saw its busiest day since French President Emmanuel Macron unexpectedly called a snap election in June.

According to a report by Bloomberg, Investors are gravitating towards credit derivatives, often the first indicators of a market downturn, in response to weak labor market data that has raised concerns about the Federal Reserve’s delay in interest rate cuts.

Disappointing tech company earnings and a decrease in consumer spending have further fueled these concerns.

Raphael Thuin, Tikehau Capital’s head of capital market strategies, voiced concerns about the “weaker macro and impact on earnings going forward,” which he feels is an underpriced risk in the markets. He suggested this could affect credit spreads, particularly when valuations are far from cheap.

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"Weaker macro and impact on earnings going forward is the one underpriced risk in the markets in our view. This could end up affecting credit spreads, at a time when valuations are nowhere near cheap," he told the outlet.

Strategists at JPMorgan Chase & Co. JPM are recommending the establishment of “cheap hedges” through the iTraxx Europe credit default swap index, in light of a shaky start to the earnings season.

BNP Paribas SA’s credit strategy desk also suggests betting on widening spreads through a CDS gauge tracking senior financial issuers.

Despite the increase in volumes, the iTraxx Europe index is trading at around 63 basis points, closer to multiyear lows than the triple-digit levels observed in 2022 and 2023. The credit default swap index has reached approximately 58 basis points, its highest level since January, but still below its five-year average.

As concerns about economic weakness intensify, traders are now pricing in more than a percentage point in Fed rate cuts this year. This comes after the US stock market’s worst two-day slide since March 2023.

Why It Matters: The escalating fears surrounding the US economy are causing a shift in the behavior of debt investors. The increased demand for insurance against corporate bond defaults is a clear indication of the growing apprehensions.

The reliance on credit derivatives as early warning signs of a market downturn further underscores the level of concern among investors.

The advice from JPMorgan Chase & Co. and BNP Paribas SA to hedge against potential risks further highlights the precarious state of the economy.

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This content was partially produced with the help of Benzinga Neuro and was reviewed and published by Benzinga editors.