Friday, December 19, 2014

FLASH UPDATE: TRV Weekly Commentary - Opportunity in IOs


TRV Weekly Commentary
Week Ending 17 Dec 2014


Comment:
This week was an active week in trading, particularly in commodities, rates and MBS derivatives on market turmoil. Below are some highlights that have contributed to the increase in vol this week:
  • WTI crude futures reached an intraday low below $55/barrel on the Tuesday (see graph)
  • The Russian ruble depreciated to a high of $79.16 USD from $64.23 USD (see graph)
  • The Swiss National Bank imposed a negative 4.6 bps deposit rate on Thursday
  • The FOMC meeting minutes reflect a close monitoring of inflation and the “transitory effects of lower energy prices” on Wednesday
  • The 10/5 spread compressed 8 bps
  • The 10yr reached an overnight low of 2.01 on Tuesday
Implied vol on 10yr swaps increased 3 ticks on these data points and we saw equities, spread and credit products sell-off. The market turmoil largely began due to lower energy prices, causing the Russian Ruble to depreciate substantially. From there, a domino effect insured with the S&P500 selling off 2.64%, the mortgage basis underperforming by 4 to 9 ticks versus 10yr hedges, and IOs cheapening between 10 and 64bps of OAS.

In IOs, we argue that it may be an opportune time to be in the market as the underlying fundamentals are intact and refi risk is contained. A meager drop in mortgage rates and an unchanged refi index support this thesis. We see the best opportunity in 3.5s of ’13 as the IO benchmark widened 64 bps this week. Another potential opportunity lies in RMBS as 60+ delinquencies are generally declining, LTVs have been improving, and dealers have inventory in their balance sheets that can be cleaned up before year-end. We have seen some paper with strong credit support and stable cash flow selling for LM70s that may be sourced cheaply.

As we prepare to launch in the next couple of weeks, we look forward to future market dislocations that will provide opportunities in our markets.

Regards,

Tradex Global Advisory Services, LLC
investorrelations@thetradexgroup.com 
203-863-1500
@Tradex_Global

Russian Ruble vs WTI crude futures


Sunday, December 14, 2014

Contagion! Is that still a word?

Liquidity in the lower rated junk bonds has already started to become tentative at best.  Over the last few months, volatility has risen significantly and a true reassessment of risk has begun with investors.  Bid-ask has been gappy and inconsistent, both on the downside and upside.   It has been fairly obvious for a long time that investors are not being compensated properly for the risk that they are taking on in the high yield market, particularly in the CCC-rated sector.  As pain from the energy sector spills over into the rest of the high yield market, and illiquidity becomes a reality, investors may soon be met with a reminder about what the word “contagion” means. 

HYG & JNK are trading at 2 year lows, and retail investors who blindly own high yield for the “safety of fixed income” are likely scratching their heads, as they wonder why and how their investment can lose in price.  They probably thought that it was just a safe yield that they could bank on.  30% of high yield ETF holders are hedge funds, and they will move the needle quickly when trying to avoid any losses from a headline risk type of trade, such as being long high yield.  Outflows have not started yet in these two ETFs, but if the past is any indicator, outflows will be large and fast.  July 2014 saw $12.6 B of overall high yield outflows; the impending problem could make July pale in comparison. 


As contagion takes hold, the illiquidity will likely become an exponential problem, as liquid equity ETF structures and daily dealing mutual funds struggle to create underlying bond liquidity, especially at a NAV that doesn’t represent significant gaps.  Once those gaps start to become apparent, trust is quickly lost in the structure itself.  NASDAQ released a white paper earlier this year, citing liquidity as the #1 ETF myth that could lead to investor losses. Lower rated high yield paper is starting to roll over…how will you be positioned? 

Enjoy the football today,

Richard Travia
Director of Research