July 22 (Bloomberg) -- Stress tests will provide stability for European lenders and clarity for investors, spurring a rally in bank debt, according to Goldman Sachs Group Inc.
Strategist Alberto Gallo says that the cost of insuring financial company debt with credit-default swaps will drop to match that of corporate bonds for the first time since January. The CHART OF THE DAY shows Gallo’s forecast that the Markit iTraxx Financial Index of swaps and the corporate Markit iTraxx Europe Index will converge.
Corporate bonds are historically more expensive to insure than bank debt. That relationship was reversed amid concern the brunt of Europe’s government deficit crisis would be borne by lenders, with the financial gauge exceeding the investment-grade index by a record 60 basis points on June 8.
“Stress tests and other policies coming through are likely to increase transparency and stability in the financial system,” Gallo, who first made the forecast July 13, said in an interview from New York. “We see the ratio of iTraxx Financial and iTraxx Europe going to one.”
Credit-default swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a company fail to adhere to its debt agreements. A basis point on a contract protecting 10 million euros ($12.8 million) of debt from default for five years is equivalent to 1,000 euros a year.
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--Editors: Michael Shanahan, Sheldon Reback
To contact the reporter on this story: Abigail Moses in London at Amoses5@bloomberg.net
To contact the editor responsible for this story: Paul Armstrong at Parmstrong10@bloomberg.net GS US
From Bloomberg Businessweek published on July 22, 2010, 5:24 AM EDT