Nerves grip market ahead of Fed

Risk assets traded in a tight range on Tuesday as nerves gripped the market ahead of tomorrow's Federal Reserve meeting.

Spreads and stocks have been hyper-sensitive recently to news relating to central banks, particularly the Fed. There was further evidence of this after the European close yesterday, when an FT report said Ben Bernanke is likely to signal that a tapering of QE is close to implementation. US markets sold off on the news, but recovered some ground just before the close after the FT journalist played down the interpretation of the story.

Bernanke will probably stress that any tightening in policy will be dependent on labour market data, and the tone of his post-meeting press conference will be crucial in determining spread direction over the summer.

European markets were relatively stable in comparison to the US oscillations yesterday. As well as the FT clarification, the Zew economic sentiment survey index from Germany beat expectations and helped support current levels.

The Markit iTraxx Europe index was just under 0.5bp wider at 108.5bps, while the Markit iTraxx Crossover was 4.25bps wider at 446.5bps. Banks were among the worst performers, with Royal Bank of Scotland continuing to lag behind its peers. The bank was 8bps wider at 198bps, and has now widened by more than 60bps since May 7. Over the same period, the Markit iTraxx Senior Financials index has widened by less than 30bps. Uncertainty over its future leadership and direction has clearly had a negative impact on the UK bank.

Telecoms were also in focus following reports that Liberty Global made a preliminary bid for Kabel Deutschland. Vodafone has already approached the German firm, a development that caused Kabel's CDS to tighten dramatically last week. From a credit perspective, Liberty's interest would probably be less preferable than Vodafone's, the latter being a solid investment grade name. Liberty's acquisition of Virgin Media earlier this year resulted in multiple rating downgrades and was emphatically credit negative; it was effectively a leveraged buyout.

Kabel's spreads widened 10bps to 155bps, a modest move and still nowhere near the 202bps level traded before the Vodafone announcement. This suggests the markets attach a relatively low probability to the Liberty deal, though investors still have to be cognisant of the risk.

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