Huge inflows into U.S. fixed income cash funds is keeping credit-default spreads tight when most credit derivatives traders would otherwise expect the possibility of war in Iraq to be forcing widescale spread widening. Concerns over a U.S.-led war would typically increase the volatility of credit-default swaps, however, since January the market has instead been seeing general spread tightening in tandem with increased anticipation of a U.S. strike against Iraq, noted one trader. The Walt Disney Co. is one name thought to be particularly susceptible to spread widening in the event of war, however traders noted that although it moved wider by around 10 basis points last week, standing at 110bps last Thursday, movement on the name has been tempered since the beginning of the year.
CDO issuance is sluggish so general spread tightening can be attributed to the approximately USD13.5 billion that has been pumped into the cash fixed income funds in January alone, said traders. According to data by AMG Data Services these inflows form a stark contrast to the U.S. equity fund market, which in the same period saw only USD3 billion in inflows, the smallest January inflow on record.
Further impact of the Iraq situation on credit-default swaps will be influenced by the duration of the war, should one begin, traders said. A long war is typically thought to be detrimental to the global economy and will have a negative impact on spreads, explained one trader. A war of a short duration, conversely, will produce a technical bounce and have a tightening effect, predicted traders.
