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So Much For Decompression

04 April 2018 by lberuti

At the end of last year, the call was almost unanimous: 2018 would be the year where valuations would be challenged. Many analysts called for an underperformance of High Yield credits against investment grade credits. At the very least they said the utmost caution was warranted. By the end of January, they were all highfiving each other. They got that trend right, and iTraxx Crossover (ITXEX) had underperformed iTraxx Main (ITXEB) in Europe, while CDX HY had underperformed CDX IG in the US. But if you look at the current situation, the European market tells you a different story. ITXEX series 29 – the current on the run index - trades 35.5bps wider than ITXEX series 28 – which was on the run at the beginning of the year -, and ITXEB series 29 trades 8.85bps wider than ITXEB series 28. Based on the above grapple, it means that ITXEX series 28 has widened by 20bps during the first quarter, while ITXEB series 28 has widened by 6bps. Based on the 4 ratio that the market uses as a rule of thumb to estimate compression/decompression between these 2 indices, ITXEX has effectively outperformed ITXEB since the 1st of January. I am not sure what the exact catalyst was over the last 2 months, but we certainly witnessed a reversal of the decompression trend that was at play earlier in the year.