Will CDS spreads tumble in February?

Discussion in 'Trading' started by ASusilovic, Jan 27, 2009.

  1. Fortis certainly thinks so.

    The bank’s analysis, which is based on Didier Sornette’s research into bubbles (think US housing and oil circa 2008), holds that recent increases in CDS spreads in both US and European markets have reached unsustainable levels and are due for a correction - sharpish.

    Per the report, by Peter Cauwels, Ken Bastiaensen and Amjed Younis:

    "Based on our findings, it is likely that the peak for the 4 major indices will be reached between the 2nd and the 12th of February, and as a result they will fall. This is particularly significant since these indices are closely watched as a “fear gauge” for Financial Markets, alongside the VIX Index, Libor-OIS spread and the spread between German bond yields versus other Euro Area government yields."

    Their conclusion is based, in part, on the application of the mathematical model of Sornette’s general theory of crashes, which they backtested using the performance of the US dollar weighted average as a data series:

    On December 5th, the toolset detected a bubble-like behavior and reported December 10th as most likely crash

    Starting on December 9th, the DXY began a consecutive drop of more than 8% until December 17th. This drawdown13 was the largest since the start of the daily DXY index in 197114 and can thus statistically be considered a crash.

    In addition to this forward test, a wide range of historical crashes15 have been analysed and the results used for calibration.

    The formula, which according to Fortis represents a so-called “log periodic power law” (LPPL) and is given by:

    p(t) ≈ A + B(tc - t)-β + C(tc - t)-β cos(ω log(tc - t) +ϕ )

    Fortis believes four of the major CDS indices - the iTraxx Crossover and Main, and the CDX High Yield and Investment Grade - which all recently hit record highs, show a ‘bubble-like formation in spreads’, per the graphs below:


  2. What will the consequences on the broader markets if the CDS spreads collapse?
  3. Steep drops in these fear indicators are bullish for equities.
  4. probably bearish bonds too..

  5. No, bullish bonds. Closing of the spreads means less risk premium, higher price, lower interest rates.

    If this is right, buy financials and watch the BAC/Merrill marks of recent reverse.
  6. Hmmm...you don't think you'll see a flight to 'quantity' to the equity markets from the 'quality' of bonds?

    I could make a case here for a big short covering rally in the US equity markets - I don't think it lasts very long, since bear market rallies usually don't. But they are violent as all hell...

    I just don't know how that would be bullish something yielding 3.5%
  7. Tide31


    This same journalist's (Stacy-Marie Ishmael) previous article from 4 days previous in the FT was so much the opposite, I wonder if she reads her own articles before going to print? I remember reading her doom and gloom article the other day. Remember, she is a Brit, their humour is sometimes off-colour to Americans. She ended the article you are quoting about Fortis with: "Ok then, lets mark our calenders!" ie: Feb 2nd or 12th.

    The headline of Jan 23rd article she ran was Brace Yourself For Record Corporate Defaults. She cites references that say that the default rate will go from 1% to 14% in just under a year. Thats an amazing stat! You can go ahead and short CDS's at these 'lofty' level's, I would use a tight stop though - IMHO.

    see article:

  8. I think the article posted by the OP from her is based on Fortis' opinion, and not her own..
    I could be wrong.
  9. Tide31


    Right PohPoh, but so was the article I mentioned. It was chock full of quotes like the article posted that started this thread. This is what journalists do. What's her point though, On Friday she 'quotes' people saying that the sky is falling, and on Tues everything is fine and buy Corporates (short CDS)?

    Guess her kids didn't make her take them to Circuit City's bankruptcy liquidation sales over the weekend like mine did. If so, she might not have 'changed' her view so quickly? That's why I think in earnest that she wrote it tongue in cheek - If you read between the lines about a rally in Corporates, only reason I can see that puts (CDS's) would "sharply" decline next week. Ridiculous, shoddy, misleading article to report what this guy sees in his tea leaves at Fortis. Technical Analysis can be great, but after coming to a conclusion one should step back, look at it, and see if its 'viable'. A 'sharp' decline in CDS's next week is not. More than IMHO, it's just not.