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Are Bases The Perfect Hedge?

08 April 2015 by lberuti

Quantitative easing has created a low yield environment hardly ever seen before. The action of the ECB since the beginning of March has almost sent interest rates to 0 up to the 5 year point all around Europe. An unprecedented number of corporate bonds with maturity up to 5 year now yield less than 1%. It is no surprise then to see these corporates flood the market with record high amounts of bonds. In March alone, according to Bloomberg, excluding Governments and Financial institutions, €400bln were issued. So much so, that while European government bonds are mopped up by the ECB, corporate credit spread have stopped rallying. That definitely raises the question of the ability of credit funds to withstand any marked to market loss or cope with any sizeable redemption. Less than half the bonds issued have a traded CDS. That means investors will not be able to turn to the single name market to mitigate their risks. They will have to rely on macro hedges, like credit indices and particularly iTraxx Crossover which best fits this universe of non-tradable names. If there is any blip in the market, on the back on this likely reach for index protection, you can be sure it will directly impact index bases, which will turn positive very rapidly. And, as you can see on the above grapple, iTraxx Crossover’s basis has been stubbornly negative over the last month. If you can buy this basis, you will get an efficient hedge that will not cost you a penny.