Wednesday, 27 March 2013
Cross-asset credit/volatility in Europe and movements in financial spreads
"Now the reason the enlightened prince and the wise general conquer the enemy whenever they move and their achievements surpass those of ordinary men is foreknowledge." - Sun Tzu
Following the events in Cyprus and in particular the harsh conversations which followed surrounding bail-in procedures, we have seen an increasing pressure on financial CDS spreads relative to High Yield and relative to Investment Grade Non-financial spreads - chart source Bloomberg:
In blue - Itraxx Financial Senior 5 year CDS index representive of risk perception for European financials.
In red Itraxx Crossover 5 year index representative of high yield risk gauge in Europe.
Both indices have been adjusted for the roll which happens every 6 months.
As pointed out by our good cross-asset friend, in terms of cross-asset credit/volatility, recent historical regressions are perfectly in line between the Itraxx Crossover and the Eurostoxx 50 volatility.
Eurostoxx 50 volatility and Itraxx Crossover spreads are perfectly inline based on 1 year historical data.
One can see in a similar analysis that there is a clear underperformance of European financial spreads based on the Itraxx Financial Senior index versus the Eurostoxx 50 volatility level (1 year at the money):
Itraxx Financial Senior index versus Eurostoxx 50 1 year at the money volatility.
Spread between the Itraxx Financial Senior 5 year CDS index versus the theoretical Itraxx Financial Senior (recalculated via regression with 1 year volatility Eurostoxx 50):
As displayed in the above graph, Itraxx Financial Senior spreads are wide versus Equities volatility.
It seems that Eurostoxx 50 volatility is relatively cheap versus the Itraxx Financial Senior CDS spreads.