CDS indices are tighter due to indices having their biannual rolls and not because of any significant relief in the market. The ECB has indicated that it might start buying corporate bonds in the secondary market. If this proves to be the case, it could be very positive for cash bonds. Finally, primary market activity continues to be high.
Due to the iTraxx indices rolling last Friday, the price on the new on-the-run index cannot be compared to the old one as a number of names have been replaced (see Weekly Credit Update from 13 March 2009). The average credit quality of the new index is stronger than the old one. The new iTraxx Europe index trades at 163bp while the Crossover index trades at 910bp. The old indices trade at 184bp and 1133bp, respectively.
The cash market for subordinated bank capital has rebounded sharply during the week. We see this as a consequence of the rally in bank equity prices but also due to a number of banks (e.g. UBS, RBS, Lloyds) announcing tenders for some of their outstanding subordinated bank debt. The incentive for banks to tender their Tier 2 capital is that it will increase their Tier 1 ratio (but decrease their Tier 2 ratio) due to banks recording a capital gain. Going forward, it is likely that more banks will announce tenders of subordinated debt. Consequently, we believe that the pressure on subordinated bonds will ease considerably in the short term.
On another note, the vice president of the ECB, Lucas Papademos, indicated in a speech yesterday that the ECB might start buying corporate bonds in the secondary market in order to increase liquidity and lower funding costs. If the ECB decides to follow this route, it could potentially be very positive for Euro cash bonds. When the Bank of England started buying corporate bonds a little more than a month ago, it caused GBP corporate bonds to significantly outperform.
