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The cost to protect against defaults on U.S. corporate bonds declined to the lowest in more than two years as investors wager that earnings will beat analysts’ expectations and the global default rate fell for the first time in two years.

Credit-default swaps on the Markit CDX North America Investment-Grade Index Series 13, which is linked to 125 companies and used to speculate on creditworthiness or to hedge against losses, fell 1.5 basis point to a mid-price of 75.75 basis points as of 4:09 p.m. in New York, according to Phoenix Partners Group. The index is trading at the lowest level since Dec. 14, 2007, when it was 75.2 basis points, according to CMA DataVision prices.

Contracts to protect against default fell as analysts predict Standard & Poor’s 500 companies will snap nine straight quarters of declining profits, easing concern about lost jobs, while retail sales may have risen in December. Swaps tied to the bond insurance units of MBIA Inc. and Ambac Financial Group Inc. fell for the third day since an auction that set a higher-than- expected recovery value on securities backed by a unit of insurer FGIC Corp.

“Earnings will be better than people think, and the tightening trend will be justified,” said Mikhail Foux, a credit strategist at New York-based Citigroup Inc. “The economy will continue to improve for the first half of the year, if anything surprising people on the upside.”

The rate at which companies default on their debt fell as the world economy exits the deepest recession since World War II, according to Moody’s Investors Service.

Default Rate Falls

The global speculative-grade default rate fell to 12.5 percent in the fourth quarter of last year, from 12.6 percent in the previous three-month period, after peaking at 12.9 percent in November, Moody’s said in a report today. The U.S. default rate also declined, to 13.2 percent, from 13.4 percent in the third quarter, according to the report.

The fourth-quarter reporting season started today, with New York-based Alcoa Inc., the largest U.S. aluminum maker, saying profit trailed analysts’ estimates as the company faced higher energy and currency costs.

Contracts to protect against default on Alcoa debt tightened 13 basis points to 150 basis points before the company reported earnings, CMA data show. Credit swaps linked to Southern California Edison Co. tightened about 10 basis points to 75 basis points in active trading. The utility is based in Rosemead, California.

“We’re still wide by historical standards,” Foux said. “The trend is still bullish.”

Swaps on Insurers

Swaps on MBIA Insurance Corp. have dropped 6.9 percentage points to 55 percent upfront since Jan. 6, according to CMA DataVision. That means the cost to protect $10 million has dropped $690,000 initially to $5.5 million in addition to $500,000 a year.

Ambac Assurance Corp. swaps have dropped 10.1 percentage points to 57.6 percent upfront, CMA data show.

Traders are speculating the swaps on the insurers may be worth less than anticipated after an auction to settle contracts on FGIC’s Financial Guaranty Insurance Co. set a value of 26 cents on the dollar for the mortgage and home-equity loan debt backed by the company.

The price “came in notably above the high-teens recovery rate expected by the market,” said Tim Backshall, chief strategist at Credit Derivatives Research LLC in Walnut Creek, California.

Recovery Expectations

The auction value means buyers of swaps on FGIC will be paid 74 cents on the dollar, at least 6 cents less than the market had been pricing in. The market had been anticipating a recovery of about 18-20 cents the day before the auction, according to Barclays Capital prices.

Swaps on MBIA have dropped for five straight days. Contracts on Ambac have fallen six straight.

The Markit iTraxx Europe Crossover Index of credit-default swaps dropped about 11.5 basis points to 382, according to Phoenix.

“Markets expect a positive earnings season,” said Philip Gisdakis, a Munich-based strategist at UniCredit SpA. “That might create a risk of disappointment.”

Profits at companies in the Dow Jones Stoxx 600 Index may have increased a share-weighted 7.9 percent in 2009, and will rise about 30 percent this year, according to data compiled by Bloomberg.

The Markit iTraxx Europe Index of 125 companies with investment-grade ratings declined 2.5 basis points to 65 basis points, according to Phoenix.

A decrease in the Markit index signals improvement in investor confidence. Credit swaps pay the buyer face value if a borrower defaults in exchange for the underlying securities or the cash equivalent. A basis point is 0.01 percentage point and is equal to $1,000 a year on a contract protecting $10 million of debt.

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Tags: Finance