The T Report: CDS Roll – More Technical Than Meaningful

A relatively quiet morning in credit in spite of the CDS rolls.  The “on the run” single name CDS contract changes from March 2017, to June 2017.  So every single name 5 year quote will now be for June 20, 2017.  A little bit technical for the market, and a lot annoying for most clients.  The European indices roll today and IG index rolls today in the US (there is a lag for HY indices).  So IG18 is now the “on the run” investment grade CDS index – there is exactly one name change between IG17 and IG18 – kind of makes you wonder why there isn’t a better methodology than leaving all these half orphaned indices out there.

Typically indices that go “off the run” trade tighter than they should as people long credit are happy to roll down the curve; whereas, the hedgers like to be in the more liquid “on the run” contract and like the slightly extra duration due  to the longer maturity.

None of the indices are doing much, though all are a bit wider.  It is time to watch to see if shorts waited for the roll to wade back in.  That is often the case, especially when the market as a whole has been strong, shorts will hold off until after the roll.

Spanish 10 year bonds deserve continued attention. They failed to finish higher yesterday (yet again) and are lower again today.  The moves are small, and its yield has only  moved from 4.98% on the 9^th, to 5.19% today, but that move is occurring in spite of the LTRO and a 3% positive move in the IBEX 35 stock market over the same period.  Spanish CDS is at 408, only 85 bps from its all time wide level of 492 in November.  10 year bonds were over 7% at that time, so not only is the bond market leaking, but the less manipulated CDS market is far less comfortable with Spanish credit risk.  In spite of all the flaws of CDS (and there are many), it has proven its worth in Greece, and isn’t as impacted by the SMP and LTRO, so may reflect something closer to a “free market” price.  It is important to remember that so many of the prices we look to, in order to draw comfort that the market is okay, and manufactured prices and contain far less information than they used to.

Closer to home, we almost had a tri-fecta yesterday as LQD and JNK both saw shares outstanding decline yesterday, while HYG’s shares outstanding remained unchanged.  Where is the money going?  With the ETF’s still trading at a premium to NAV, I don’t think the share changes are the result of the arb community returning shares.  The cash markets were strong yesterday, but not “en fuego” so it is unlikely that dealers were turning in shares to get hard to source bonds out of the ETF’s.  That leaves retail selling.  Is retail finally getting out of fixed income and moving into stocks?  Or is retail saying they have rolled the dice long enough, made some great money, and are now shifting more to cash, hoping for a back-up to reload?  The flows so far are small.  Yesterday the markets looked as though it may have been a shift out of fixed income and into stocks, but I don’t believe that.  Americans have become used to buying things on sale, I think that applies to the stock market as much as anything else.  Why would they buy now when prices are a lot higher, and are extremely dependent on central bank activity globally?  I suspect they are shifting their weightings within fixed income.  Some is moving to cash, and some to treasuries.  If you bought HYG on December 15^th (nowhere close to the lows), you have made about $4 per share and $1.50 in dividends.  TLT (long dated treasuries) has dropped $10 per share since then.  So with spreads compressing and treasury yields rising we may just be seeing a shift out of credit risk into treasury risk (TLT shares outstanding jumped yesterday).  That makes more sense than shifting money out of fixed income into equities at this late stage, in spite of the longs on wall street begging retail to join the party.

Concerns are appearing again about the Chinese economy.  They have been out there, and the data has been weak, but it seems like today the market has decided to at least let it creep back into its pricing decisions.  Same with the potential for stagflation in Europe – nothing new, but once again people are focusing on it.

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E-mail:    tchir@tfmarketadvisors.com

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