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Derivatives

Spread Tightening Takes CDS Mart To Uncharted Territory

Tightening credit spreads last week saw the European iTraxx index drop below 30 basis points for the first time.

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Tightening credit spreads last week saw the European iTraxx index drop below 30 basis points for the first time. The single credit-default swaps which form the index tightened more than the index itself, that provided opportunities for sophisticated players but left single-name flow players hunting for yield. "When we are talking to people in the single name flow market, it's very difficult to come up with trade ideas that work," complained one trader.

The five-year iTraxx crossover index tightened around 14 basis points last week to 156 bps from 170 bps the week before. But the average of the index's single names was around five basis points wider and traders reported market players trading this differential, dubbed basis to theoretical. This can be done by selling protection on the index and buying protection on a basket of names. Players benefit if the basis reduces and also if the names in the basket under-perform, dealers explained.

Officials also noted the demand for yield pushed collateralized debt obligation investors into longer-dated trades. "More people are moving in to seven-year of ten-year deals," noted one trader at a French house. "This will cause a flattening of the curve," he added. Marcus Schueler, managing director in integrated credit marketing at Deutsche Bank in London, said, "We have seen clients putting on flattening trades, mainly in iTraxx High Vol this week, by selling 10y protection versus buying 5y protection." He noted the five-year/ten-year High Vol curve had flattened by one basis point as a consequence.

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