Halister News

(Bloomberg) -- The volatility of iTraxx Main may be set to rise given the diminishing risk/reward for further credit tightening as peripheral spreads face widening pressures from rising political risks, Bloomberg strategist Tanvir Sandhu writes.

• Legal hurdles faced by the ECB due to risks of contravening the Maastricht Treaty’s prohibition of monetary financing may also push up volatility in the iTraxx Main index
• 1-month realized vol on iTraxx Main, an index of credit- default swaps on investment-grade companies, is in the lower quartile of 5-year range and may move higher as local vol shocks may become more common, see chart here
• While the ECB protects the extreme right tails with CSPP and with any widening likely to be contained, investors may become reluctant to sell vol given the rising political risks
• BTPs may trade more like credit instruments vs duration assets in the second half of 2017 to price further QE tapering risks in 2018
• Realized 1-month volatility of BTP futures is at ~8 vs ~4 in September, which was near the lowest levels on record
• Regression analysis for BTP/bund vs 5Y iTraxx Main prior to ECB QE had R^2 = 0.955, y = 2.387x-21.228 , while after R^2 = 0.056, y = 0.359x+98.518, see here
• Other risks that may squeeze longs include acceleration in issuance offsetting ECB buying, oil volatility and a dollar- strength driven weakness in emerging markets
  • 1y regression analysis for WTI vs 5Y iTraxx Main prior to ECB CSPP announcement on March 10, 2016 had R^2 = 0.608, y = -0.599x+96.755

• NOTE: Tanvir Sandhu is an interest-rate and derivatives strategist who writes for Bloomberg. The observations he makes are his own and are not intended as investment advice.