Derivs - Credit

If one were to look at the week-on-week change of the main credit indices, it would be perfectly understandable to assume that it was another uneventful few days in the markets. The Markit iTraxx Europe was trading at 61.5bp on December 18, just 1.5bp wider than the previous week. The Markit CDX.NA.IG was 3bp tighter at 66bp over the same period.

Société Générale is expecting negative basis trades to return in 2015, in contrast to the consensus view among investors and other market commentators who believe that tight credit spreads in cash could tighten even further if the European Central Bank goes ahead in buying corporate bonds as part of a quantitative easing programme.

Hedge funds and credit valuation adjustment desks are playing the cash versus credit default swap basis on Italian government bonds after it was driven tighter by the performance of the 30 year swap, which went below 1.50% last week for the first time in its history.

Hedge funds are using synthetic leveraged credit structures, such as tranches on the iTraxx Main and Crossover indices, to meet return targets in the face of low credit spreads that are a consequence of European Central Bank policies.

Overall credit default swap notional that was reported to swap data repositories last week increased by 33% from the previous week, according to data from the International Swaps and Derivatives Association.

The European Commission has extended the mandatory capital standards for exposures to central counterparties under the Capital Requirements Regulations. Recognising that CCP authorisation and compliance requires more time to complete, regulators have extended the deadline by six months.

Asset managers are extending their maturities in credit default swaps on iTraxx indices to benefit from wider spreads on seven year and 10 year trades.

Volatility was the name of the game earlier in the first quarter as credit was swept up in the maelstrom affecting other asset classes, particularly US Treasuries and equities. The main credit indices spiked upwards and the Markit VolX Europe, which tracks realised volatility in European investment grade CDS, spiked upwards to 75%, its highest level since the taper tantrum of 2013.

Fast money investors had been buying short-dated volatility in iTraxx Main in the run up to the European Central Bank meeting on December 4, with sellers of volatility returning afterwards. This a theme that has been recurring in the credit options market pre- and post-ECB meetings.

Central counterparties have a duty to work on CCP risk, however, the European Market Infrastructure Regulation recovery and resolution framework is sufficient to prevent the buildup of systemic risk as clearing houses become vital to derivatives market infrastructure with the start of clearing in Europe next year.

Investors may switch from corporate bonds to credit default swaps next year if the European Central Bank goes ahead with plans to buy up bonds.

Overall credit default swap notional that was reported to swap data repositories last week increased by 48% from the previous week, according to data from the International Swaps and Derivatives Association. Overall interest rate derivatives trading that was reported was also up by 54% from the previous week, following a week of moderate decreases in trading for both CDS and rates.