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Bailout gives Europe edge over US


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Companies in Europe are perceived to be the safest compared with their US counterparts in 17 months as risks of a currency breakup diminish while politicians in the world's biggest economy struggle to cut the nation's deficit. The Markit iTraxx Europe Index of credit-default swaps on 125 investment-grade companies from Spain's Telefonica to engine-maker RollsiRoyce exceeds the US equivalent by the least since July 2011, with the gap narrowing to 20 basis points. Their bonds are also gaining, with relative yields dropping below their US peers for the first time since June of last year.

Europe is making a comeback in the debt markets as European Central Bank President Mario Draghi pledges to do whatever's necessary to protect the euro, with the government bonds of Greece, Portugal, Ireland, Italy and Spain generating the biggest returns since June of 26 sovereign markets tracked by Bloomberg/EFFAS indexes. At the same time, lawmakers in the US are bickering over how to avert more than $600 billion in mandated spending cuts and tax increases. "The US 'fiscal cliff' has eclipsed the euro zone crisis as the focal point for market uncertainty," said Nicholas Spiro, managing director at sovereign risk consulting firm Spiro Sovereign Strategy in London. The ECB "is underwriting everything now."

Europe's credit rally has fed through to the high-yield debt market, with junk bonds headed for the best year since 2009, almost double US returns. Speculative-grade debt in euros has returned 25.1 per cent last year, topping the 14.1 per cent gain for American junk bonds, according to Bank of America Merrill Lynch index data.

"We look at Europe as the biggest opportunity globally," Bruce Richards, chief executive officer of Marathon Asset Management, which manages $10 billion of assets, told Bloomberg Television's "Market Makers". "There are going to be a lot of assets available."

While corporate bond yields in Europe dropped to a record 2.13 per cent in December, from 4.4 per cent at the start of the year, according to Bank of America Merrill Lynch's EMU Corporate Index, the price for easing Europe's debt crisis is mounting. The first tranche of as much as 39.5 billion euros ($52 billion) of a bailout for Spanish banks will be disbursed next week as European finance chiefs approve the latest 34.4 billion-euro payout to Greece. That's on top of the 148.8 billion euros the nation's already received, according to the Ministry of Finance in Athens.

Portugal will get a further 2.5 billion euros of its 78 billion-euro aid programme in January, while Ireland has tapped 55.3 billion euros of its 67.5 billion-euro rescue fund. Cyprus is also negotiating a bailout.

Since July 26, when Draghi said he would do "whatever it takes" to save the 17-nation euro, the currency has appreciated versus each of its 16 major counterparts tracked by Bloomberg except the Norwegian krone. Odds on a euro breakup by the end of this year fell to 1.7 per cent from 39.4 per cent in June, data compiled by Dublin-based Intrade show. The probability of that happening by the end of 2013 has fallen to 33.3 per cent from 57.6 per cent. Bloomberg/EFFAS indexes show the five biggest bond gains since June are nations in the EU, ranging from 9.42 per cent for Spain to 124.2 per cent for Greece.

In the United States, the Congressional Budget Office says the failure of lawmakers to avert the so-called fiscal cliff of mandated tax increases and automatic spending cuts starting in January may tip the economy back into recession. Default swaps on high-yield companies in Europe are the safest relative to the US since October 2011. The Markit iTraxx Crossover Index of contracts on 50 companies with mostly high-yield credit ratings dropped 36 per cent since the start of the year to 486 basis points from 755, while the Markit CDX North American High Yield Index fell 24 per cent to 516 from 680.

A basis point on a credit-default swap protecting 10 million euros of debt from default for five years is equivalent to 1,000 euros a year. Swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements. At least 10 companies in the European index, including Credit Agricole and Iberdrola, have fallen by more than 50 per cent in the last six months, while only Computer Sciences and Goodrich dropped by more than half in the US. Investment grade securities in Europe are poised to outperform the US last year, returning 12.1 per cent compared with 10.5 per cent in America. The relative yield on Bank of America Merrill Lynch's EMU Corporate Index of investment-grade bank and company bonds fell below the spread on the bank's US Corporate Master Index last month for the first time since June 2011. The European measure last week was 10 basis points lower than the US after being 59 basis points higher a year ago.

"The ECB has taken the tail risks out of the equation," Saul Doctor, a strategist at JPMorgan in London, said in a phone interview. "People are getting more comfortable with risk in Europe and they're starting to buy a lot more peripheral exposure."

ABIGAIL MOSES/Washington Post-Bloomberg News


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