London plays catch-up on rally

Central bank activism and surprisingly good economic data helped the credit markets continue to rally after a long bank holiday weekend in London.

The Reserve Bank of Australia on Tuesday followed the lead of the ECB last week and cut its benchmark interest rate by 25bps. However, unlike the ECB's action, the move by the Australian central bank was not expected by the markets, so came as a pleasant surprise.

The RBA, with rates set at 2.75%, has more room for manoeuvre than central banks in other developed countries, where the zero bound for rates reduces the efficacy of conventional monetary policy.

ECB president Mario Draghi yesterday gave another strong indication that the ECB is ready to implement further unconventional measures. Draghi said that the deposit rate could be cut below zero if necessary, reiterating his market-boosting comments from last week. But better than expected German factory orders - they increased by 2.2% month-on-month - may delay the central bank entering unchartered territory.

Peripheral eurozone countries have benefitted from the ECB's support, and Portugal took full advantage today by selling its first new government bonds since requesting a bailout more than two years ago. The sovereign sold €3bn in 10-year bonds, its first full auction since February 2011.

Portugal's CDS rallied by only 3bps to 340bps, but this is still its tightest level for over two-and-a-half-years.

Corporate credit was also tighter, driven by peripheral names and banks. The Markit iTraxx Europe was trading at 89bps, 2.5bps tighter than Friday's close.

In the US, the Markit CDX.NA.IG looked set to close below 70bps for the first time since November 2007. Roll effects and constituent changes obviously need to be taken into account, but it is still indicative of a market rallying strongly.

A former member of the CDX.NA.IG, bond insurer MBIA, was in the news yesterday after it reached an agreement with Bank of America, ending a protracted legal battle. BofA will pay MBIA $1.7bn, provide a $500m credit facility and cancel considerable amounts of CDS protection bought from MBIA.

The settlement is hugely positive from a credit perspective for MBIA - if an agreement hadn't been reached its insurance subsidiary MBIA Insurance Corp would have been wound up. Liquidity has been vastly improved by the BofA payment and it leaves MBIA in a better financial position. MBIA's spreads tightened dramatically yesterday and continued to rally today - they are now 350bps, more than 550bps tighter than Friday's close.

The improvement in the insurance subsidiary is even more marked. It was trading at 2241bps on Friday (although it was actually quoted upfront); now it is quoted at 633bps, establishing its status as an unlikely survivor of the financial crisis.

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