Ukraine credit under scrutiny

Emerging markets spoiled what was an otherwise solid day for credit markets, with Ukraine in particular under increasingly intense pressure.

The sovereign was downgraded to Caa1 from B3 by Moody's last Friday, the agency citing Ukraine's low foreign exchange reserves and high external debt repayments over the next 12 months. Russia's fierce opposition to a proposed free trade agreement with the EU has come at an inopportune time and added to the country's woes.

News that China had agreed to purchase 9% of Ukraine's agricultural land - an area roughly the same size of Belgium - might have provided a short-term boost. But the reports were denied by the Ukrainian party involved, and there was no stopping the widening in Ukraine's credit spreads. The sovereign's 5-year CDS widened 104bps to 1065bps, and have now given up nearly 200bps since Friday's close.

Even more worrying is the rapid inversion in Ukraine's credit curve. On Friday, the 5-year spread was trading over 100bps wider than the one-year; now the latter tenor is wider, a classic sign of credit distress. Ukraine's liquidity situation is clearly a major concern for investors.

Other emerging market names, such as Indonesia and Turkey, also widened, perhaps reflecting the confusing messages from US Fed officials. It is apparent that the FOMC is divided on the timing of QE tapering, leaving the markets none the wiser on the issue. Emerging markets are more sensitive than most asset classes to US monetary policy, and we can expect further volatility when Fed grandees make pronouncements.

Conditions were somewhat calmer in developed markets, and credit was treading water ahead of the US non-farm payrolls reports and the start of earnings season next week. We may well see a torrent of new bond supply in the primary markets as issuers take advantage of the stay of execution from the Fed.

The rally gathered momentum late in the afternoon and the Markit iTraxx Europe was trading 2.25bps tighter at 98bps, while the Markit CDX.NA.IG was 1.25bps tighter at 79bps.

Download full article