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Time For Relative Value?

12 July 2016 by lberuti

During the Brexit led sell-off, which arguably lasted 72 hours, iTraxx Main (ITXEB) underperformed CDX IG, with the ITXEB-CDXIG spread moving from flat to +8bps on the 27th June. From then onwards, it has been one-way traffic, and the rally that followed has not only brought all indices through their pre-Brexit levels, but it has also pushed ITXEB almost down to the same level as CDXIG. They closed tonight at 71bps and 70bps respectively. Based on that, it is hard to imagine that worries around the Italian banking sector have been on the rise, and that bail-in is still a distinct possibility. As it stands, challenges facing European credits do not attract a big risk premium, and some are beginning to argue that it is time go short risk in Europe and buy protection on ITXEB, while going long risk in the US and selling protection on CDXIG. During the February sell-off which had nothing to do with European systemic risk, ITXEB widened 32bps from 94bps to 126bps compared to 22bps in CDXIG which went from 104bps to 126bps. Imagine what could happen if the market decides to stop pricing out Brexit…