Markit Recap – 10/6/2014

We remarked last week that volatility had returned to the credit markets, and the spread oscillations this week suggests the trend is set to continue.

However, this was no typical period for CDS.The vast majority of indices rolled on October 6^th, later than the scheduled date of September 22^nd, due to delays in adherence on the protocol for ISDA 2014 definitions. The roll usually increases activity and that was the case again, so it was no surprise to see some volatility.

The Markit iTraxx Europe was trading at 68bps, 8bps wider than the previous series. The new constituents in Series 22 are, on average, stronger credits than the names removed, and along with the maturity extension of the new contract, pushed the on-the-run index wider in comparison to its predecessor.

But there were also fundamental reasons driving spreads wider. German industrial production figures declined by the largest amount for more than five years in August, adding to the considerable pessimism surrounding the eurozone’s economic fortunes. Perhaps the poor economic data increases the probability that the ECB will implement full QE – including government bond purchases – sooner rather than later. All things being equal, this would be positive for risk assets. But it is by no means certain that full QE is possible in a politically-riven ECB, and the primary problem in the eurozone remains a lack of demand. Governments, particularly in Germany, need to make a contribution through fiscal policy, as the IMF and others have recommended.

Eurozone sovereign CDS spreads are relatively unresponsive to economic data – the ECB’s ‘whatever it takes” commitment’ has seen to that. But emerging market CDS are more sensitive to fundamentals, and we have seen significant moves in the some of the most liquid names. Brazil’s spreads widened from 125bps to 175bps in the run-up to the first-round of the presidential election on October 5^th, with opinion polls indicating a highly uncertain outcome. Brazil’s president, Dilma Rousseff, emerged as the winner, but failed to gain sufficient votes to avoid a second-round run-off. The sovereign’s CDS rallied on the news – the surprise runner up, Aecio Neves, is regarded as market-friendly. More volatility can be expected ahead of the final vote October 26^th.

China has also seen its spreads widen, though they are significantly tighter than its fellow BRIC Brazil. The ongoing protests in Hong Kong have added political risk into the mix of concerns, along with slowing growth and the outsized shadow banking system. China’s medium-term direction is sometimes overlooked in this era of central bank domination, but it remains a key factor for global economic growth.

Contact: Gavan Nolan 

Gavan.Nolan@markit.com