The apparent trigger for the rally — which came as a complete surprise — was the release of benign US inflation data for April on Wednesday morning, which set the 10 year Treasury rallying to a three month low yield of 4.02%.
Taking that together with the strong recovery on US stock markets from Monday to Wednesday and a drop in the oil price to $47 a barrel on Wednesday, bond investors and traders began to buy again.
The relief was particularly intense as the first two days of the week were as painful as any the market has experienced in the last two turbulent months since the sharp rise in oil prices at the beginning of March.
Paranoia about hedge funds collapsing and taking the world's financial system down with them reached its height on Monday and Tuesday, with bond specialists talking about systemic risk and a repeat of 1998, when the hedge fund Long Term Capital Management (LTCM) imploded and had to be rescued by Wall Street banks to avoid a credit crisis.
"The market is really spooked today and all of a sudden people are making doomsday predictions about how far this could go," said one senior debt capital markets originator at a European bank on Tuesday, in a typical comment.
"We've been through a meltdown in the equity markets, but have never seen what would happen in the event of a true meltdown in the credit markets. All of a sudden that is causing people to ask a lot of questions."
Two days later, the mood was transformed. "The concern about losses at hedge funds has definitely died down this week," said a senior syndicate manager at one of the biggest bond houses in New York. "We have seen pretty significant improvement in secondary spreads over the last few days, so at some level the market is definitely back up and running."
Even Fitch Ratings' downgrade of Ford Motor Co and Ford Motor Credit Co to BBB yesterday (Thursday) afternoon in New York merely emboldened the market further.
Although there is no doubt that hedge funds have suffered heavy losses in recent weeks and markets are expected to remain volatile, market participants are no longer expecting a seizure on the scale of LTCM's liquidation.
"The concerns are very real because there are a lot of hedge funds out there and they all end up doing the same trade, but that said, their losses aren't expected to cause systemic risk," said one head of emerging market bond syndicate in New York. "That's part of the reason behind the equity rally this week — people are getting less concerned about systemic risk."
US high grade issuers relish flight to quality
The better tone in the market led to a resumption of issuance in the US and Europe, where BASF and Sanofi-Aventis proved companies could issue again in euros, even if they are both double-A rated.
But investors were still very much dictating price. With a continued lack of hedge fund buying in the new issue market, money managers, insurance companies and pension funds favoured high quality borrowers in a classic flight to quality.
The Province of Quebec, keen to capitalise on this demand, and spurred by the rally in the 10 year US Treasury after the benign inflation numbers on Wednesday, brought a $750m 10 year offering that day and increased it to $1bn.
Lead managers Canadian Imperial Bank of Commerce, Citigroup, Credit Suisse First Boston and Merrill Lynch priced the deal at 54bp over Treasuries, slightly inside its mid-50s price guidance.
"It was almost as if the volatility which has been detrimental to many other issuers enhanced the reception for Quebec," said a banker at one of the leads.
Quebec paid little if anything in the way of a new issue premium, coming only 1.5bp wider than its outstanding 2014s on an asset-swapped basis.
Other borrowers keen to make the most of the Treasury rally and tighter secondary credit spreads included Capital One, the credit card bank, and First Data Corp, which provides payment and processing services to the financial industry.
Capital One, led by Lehman Brothers and Wachovia Bank, increased its $300m 10 year offering to $500m and priced it at 141bp, at the tight end of its 143bp area talk.
Although rated Baa3/BBB-, it was seen as an opportunity by investors to pick up yield on an improving credit, so paid a smaller new issue concession than other triple-B credits in the market.
First Data, rated A1/A+/A+, was another issuer inspired by Wednesday and Thursday's positive market tone, jumping into the market with $500m of five year and $500m of 10 year bonds, led by Wachovia.
More complicated triple-B credit stories like RR Donnelly, a Chicago-based printing and information services company, paid dearly for market access.
It priced $500m of five year fixed rate bonds at 124bp and $500m of 10 year bonds at 146bp. That compared with the 130bp trading level of its outstanding 2014s, and came a day after it was downgraded by Moody's.
Bankers were also encouraged by signs of an increase in deal size this week. Tranches earlier this month were in the $250m to $300m range, and have now increased to around $500m on average, the exceptions this week being issuers like Quebec.
Floating rate notes remained the most in-demand sector of the high grade unsecured bond market, as evidenced by the success of A2/A rated CIT Group's $800m three year floater.
Barclays, Bank of America and Bear Stearns increased the deal from $500m and priced it at 21bp over three month Libor.
