28 August 2014 by HCM
Risk premium curves are flatter on the long end than they are on the short end, particularly for investment grade names. So as we get closer to the roll dates, the 5 year 10 year slope tends to steepen in an otherwise stable environment. Over the last month, iTraxx Main 5 year moved from 62bps to 59bps, while iTraxx Main 10 year moved from 100.5bps to 101.5bps, which is fairly consistent with that phenomenon. During the same period, single names hardly traded on longer dated maturities (between 7 and 10 years) and dealers have left their curves’ quotes unchanged on many of them. That led to an optically wide basis between iTraxx Main 10 year and its theoretical value, while this basis is worth less than 8cts on iTraxx Main 5 year. That divergence between the index curve and its fair value is an illusion : when checked on their actual offers on 10 year maturity CDS, dealers systematically rerack them wider. People selling steepeners on indices based on fair value are currently playing a dangerous game.