“Panic selling” has hit the U.S. and European credit derivatives markets, and the two main players in that game – hedge funds and investment banks – are coming up losers. Financial Times reports that the selling activity has dramatically forced down the price of credit default swaps, which make up the majority of the credit derivatives market. Evidence of the decline in Europe is in the index iTraxx, which lost 16% in the past two weeks to bring it to a record low. As a result, the HFs and banks, which are the top purchasers of the CDS, have had to sell the instruments to cover their losses. The mood swing, says FT, has taken many investors by surprise, as they were looking forward to a rise in the cost of debt insurance. But it was not meant to be, as a tripleheader of factors have socked prices – namely corporate earnings have been robust, expectations of further rate hikes in the U.S. have shifted and there has been an increase in CDS trading connected to the new kids on the block, the so-called “constant proportion debt obligation.” The forced CDS selling, say analysts, has made the market swing appear that much worse. The trend will likely continue, as BNP Paribas Research wrote late last week in a research note, “A number of [investors] appear to have finally thrown in the towel for 2006 and with the market sensing this move, it has further deepened their pain, creating a classic short squeeze.”