Macro drivers set to give lift to CDS tranche trading

Dan Alderson

Deputy editor

Credit index tranches look to be on course for a busy year, with volumes robust so far in 2022, despite key relative value trading themes having not delivered so far. Tranche usage could also be about to step up as central bank policy and other macroeconomic drivers take hold.

“For index tranches, it has been fairly active this year,” says Steve Xin, a New York based correlation trader at BNP Paribas. The bank estimates US index tranche trading notional across the street at $26 billion, split between CDX IG and HY tranches.

The bespoke tranche business has also been promising this year, but is moored around $10 billion.

Much of the healthy tranche activity has come despite investor complaints that there have not been many pockets of opportunity, even against a backdrop of volatile indices.

Volatility picked up as April went on, with an array of challenges coming into view, such as geopolitical risk and slowing growth in Europe, covid-19 case numbers in China, global commodity price fluctuation, and central bank policy hawkishness — not least at the US Federal Reserve, which some expect to hike rates by 75bp at its May meeting.

“Index tranches have been fairly active”

Steve Xin, Trader | BNP Paribas

“Tranches have been underwhelming and mostly moved with deltas, so there aren’t many exciting relative value performances,” says one New York based portfolio manager.

Dispersion could change that. The iTraxx Europe first loss piece has reached an extreme base correlation of over 50%, according to IHS Markit, which could mean a reversal is due. CDX IG and iTraxx Crossover first loss tranches are in the 40% area and CDX HY — which contains a number of distressed constituents — is around 30%.

“Yes, correlation is very high in Europe, and one would doubt if it could go any higher, so the resistance to dispersion is quite low,” says the New York PM. “But it’s hard to get dispersion in iTraxx, although maybe inflation can do it.”

April did bring some signs of idiosyncratic risk returning to the wide end of the Crossover basket. French supermarket retailer Casino went from 15.5 points up front to 22.5 PUF, while its zero-month spread went from 783bp to as wide as 1,895bp on 20 April.

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Global credit funds & CLO's

May 2022 | Issue 245

Published in London & New York.