Private Risk Is Gone As Traders Hedge Long Positions With Sovereigns
The most recent broker to realize that private risk does not exist as a result of global moral hazard is Deutsche Bank, which is actively promoting ta long risk/short sovereign CDS trade. That is happening as IG13 trades at its all time record tights of 77 bps. In other words, buying an index of 125 investment grade credit provides less than 1% of incremental risk return. Pretty soon the ABX trade will be buying IG. Until then, however, the only risk continues being that of sovereign balance sheet, courtesy of onboarding of virtually all private sector risk at the Central Bank and via other backstop mechanisms.
From Deustche Bank:
We continue to think that the equity and credit markets are in good shape in isolation but that Sovereign risk/higher yields continues to be the main risk to the current equilibrium. Hedging equities and credit with Sovereign risk (CDS or Government bond markets) makes us much happier to be long. So far this trade has been working better than we would have thought. If you'd have told us 2 months ago exactly how the Greece situation was evolving and to a lesser extent how UK and US yields had moved then we probably would have thought equities and credit would be struggling a bit more than they actually are. So the long risk/short Sovs trade has been working from both sides which probably means we need to review it. Its doubtful we'll change the stance as Sovereign risk will hang around for sometime, possibly for years. The debate is to whether one should take profits in risk assets given how much they moved. For now we continue with our view that Q1 will be strong for risk.
And strictly within credit, technicals continue to push all indices tighter, particularly those where there is still some yield to be had. With banks having released the TRS spigot en masse, with hedge funds adding massive leverage in new positions as a result, a few hundred basis points can mean a nice setup as long as the market is in its upward bound melt-up trance.
In credit we've seen a large move especially in higher yielding assets. Top quality IG cash credit products were largely unchanged in spread terms as investors have piled into the higher yield of HY and Subordinated Financials. The European Financial Subordinated index is around 44bp tighter since we last published. This beta compression theme was also notable in benchmark credit indices. The Europe Xover has contracted by 80bp and the CDX HY has climbed up by more than $2. IG CDS indices across both sides of the Atlantic narrowed by over 10bp. iTraxx Fin Snr and Fin Sub indices were 12bp and 29bp tighter, respectively during the same period. The lingering concerns around Sovereign risk saw a volatile Xmas/NY period for the SovX WE index. The index closed at a new wide (73bp) just four days before Christmas
In other words, in the market's opinion, there remains almost no risk anywhere in existing secondary markets. Let the securitization (CDO/CLO, etc.) game begin anew, as the full irrational credit exuberance cycle that led to the last collapse is brought back full circle.