EUR CDS Basis Seeking Zero-Bound Highlights Yield Hunt: Analysis
(Bloomberg) -- Euro-denominated high-yield cash bonds are now approaching the most expensive levels relative to credit-default swaps in 20 months, spurring concerns about the risk of a mean reversion, Bloomberg strategist Simon Ballard writes.
- Basis currently shows a Z score of 1.93 above mean, moving toward a score of 2, a deviation some investors interpret as a signal that it could revert to the average
- As investors have pushed secondary bond spreads tighter in their hunt for yield, iTraxx Main/EUR HY cash basis has risen to -7 from an all-time low of -214bps on Jan. 21
- Risk appetite has been buoyed by both the ECB and the BOE putting in place implicit backstop bids for corporate bonds via asset-purchase programs
- In addition, spread tightening and curve flattening were likely accentuated during July, August by reduced mkt activity; those trends are now easing with investors back in the market
- Now near the highest level since Jan. 2015, the CDS-bond basis may look less attractive versus earlier this year; that, combined with any fears of a surprise Fed rate rise later this month, may damp further extension of risk appetite
- But ECB CSPP and BOE bond-buying programs will likely underpin risk tolerance levels, help to avoid capitulation
- Indeed, the technical widening of EUR HY spreads and a steeper quality curve over past week should still encourage some investors to eye credit mkt investment opportunities
- NOTE: A negative basis exists where a cash bond/index spread is wider than the corresponding CDS spread. In a negative basis, the cash bond is the cheap asset and the credit default swap is the expensive asset
- NOTE: Simon Ballard is a credit strategist who writes for Bloomberg. The observations he makes are his own and are not intended as investment advice.
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