After an expected bounce in the market for credit default swaps on the back of rally in equities, sentiment in the debt markets has deteriorated.
European credit derivative indices were trading wide of their closing levels on Tuesday. The Markit iTraxx Crossover index of mostly junk-rated borrowers’ CDS was quoted at 1092bp - at its wides of the day so far – having briefly traded inside the previous session’s closing level of 1072bp.
The iTraxx Europe index of mainly investment-grade borrowers’ CDS was quoted at 184.38bp, having traded as tight as 179.25bp this morning, after a close of 181bp Monday.
US and Japanese CDS markets also closed tighter over night.
One noticeable recent trend is the outperformance of sovereign CDS compared to corporate names. Jim Reid at Deutsche Bank says the sovereign market, one of the thinnest in terms of trading activity relative to its sentiment impact, has seen a big squeeze tighter on the back of short covering (emphasis FT Alphaville’s):
One of the problems with this market is that it is so widely quoted in the press and throughout the market that it cannot help but influence sentiment one way or the other. Yesterday’s reversal of 2009′s move saw high beta names 10-25bps tighter and low beta names 5-10 tighter. From the wides of recent weeks, they are in 100-150bps and 40-50bps respectively. However the flows we’re seeing continue to be overwhelmingly dominated by those with a desire to be short Sovereign risk. Only a very small proportion of trades are from investors genuinely looking to go outright long Sovereign risk. So short covering dominates while sentiment improves and in this still thin market the moves are brutal.
Of the G7 nations, contracts on the US, Japan, Germany, France and Italy were all significantly tighter yesterday, while CDS on the UK was unchanged.
But analysts at Commerzbank warned this strong tightening trend could be short lived, at least with respect to emerging market credit:
Following three trading sessions of stellar CDS performance, it is fair to assume some degree of pullback on CDS prices today, especially if global stocks take a pause for breath. Since Monday, 9 March Turkey five-year CDS prices have tightened 94bp, Russia five-year by 120bp, Ukraine five-year by 590bp, Kazakhstan five-year by 218bp and the list goes on and on.