It's 'roll time' for credit

It's the middle of March and that means one thing in the CDS market: index rolls.

The final lists for the roll of the Markit iTraxx indices were announced earlier this week, with no changes to the provisional lists. The iTraxx Europe saw four changes to its constituents, while the iTraxx Europe Crossover had six names change. For the full list click here. Changes to the Markit CDX indices were announced earlier this month and can be found here.

It's no secret that the CDS market has rallied in recent weeks, although it has struggled for direction over the last few days. Fundamental factors have no doubt made a contribution. But what is less known, at least to non-participants in the credit markets, is that technical flows produced by the rolls can accentuate rallies.

Spreads often tighten pre-roll as protection buyers tend to close out short risk positions. This is promptly followed by widening post-roll as protection buyers reset their positions. This can lead to the index skew increasing as the index outperforms the underlying constituents. However, there has been little evidence of that trend in this roll, and it will be interesting to see if we see spread widening after the roll on Wednesday.

We may well see spread widening anyway, although negative catalysts have been few and far between. The markets appear comfortable with the current stasis in Italian politics, a state of affairs that could change very quickly. The Italian parliament reconvened on Friday with a new government seeming as far away as ever. A fresh election looks the most likely scenario, though it will be some months before it happens. Beppe Grillo's Five-Star Movement, which holds the balance of power, might become more conciliatory and offer ad hoc support. Either way, the anti-austerity forces are gathering strength, which must be causing concern in Europe's corridors of power.

Next Wednesday will also be notable from a macroeconomic and political perspective. The Fed is scheduled to make its monthly policy decision, and Ben Bernanke's press conference will be closely scrutinised. The Bank of England's minutes have the potential to move UK markets if more MPC members become dovish. And the UK budget, while not the great event it once was, still has significance. Chancellor George Osborne is under enormous political pressure and a disastrous budget like last year could see his position threatened.

Flash Markit PMIs and a Spanish bond auction round off what should be an interesting week. For a full round of the week's economic events click here for analysis from our economists.

Download full article