The CDX emerging markets index surprised traders by tightening to a three-month low last week, despite the escalating conflict in the Middle East. Five-year spreads tightened to 141 basis points Wednesday from 186 bps two weeks ago and 214 bps in June. Emerging markets credit derivative traders attributed the tightening to indications the U.S. Federal Reserve is nearly done tightening interest rates and the view that geopolitical risks--while making headlines--are under control.
"The market was positioned for disaster," said the head of one emerging markets trading desk. "It was very difficult not to be bearish the last few months. All you had to do was open the newspaper. But the markets were betting [the Middle East] would be less contained than it is." He added, however, "If [fighting] intensifies, all bets are off."
The conflict has even benefited big oil producers such as Brazil and Russia, which each make up 13% of the index, one trader noted. Five-year Brazil CDS tightened 60 bps since last month and Moody's Investors Service Monday indicated a potential upgrade.