Credit Market Outlook & Strategy -US High Grade Strategy & CDS Research

High Grade Strategy
Despite the recent pause in the spread rally we expect a solid earnings season and a slowdown in the pace of new supply to continue to push spreads lower. Valuation remains reasonable, despite the rally, as most sectors' spreads are 50- 200% above their pre-crisis levels while leverage is declining. Recent data shows mutual fund flows into HG bonds remain robust, and insurance companies continue to have higher than typical cash balances, which are important drivers of
the favorable technical situation.

Recent spread widening is explained by somewhat weaker than expected economic data and perhaps by concerns about fiscal policy in Washington. But we expect the favorable fundamental and technical situation to re-assert itself soon and the economic data to show that solid growth is continuing. Credit Derivatives CDX sold off modestly after the strong rally in December and in the first week of January. More leverage is available in CDS-bond basis trading, potentially
increasing returns on negative basis trades. Interest in curve trades has also increased.

CDX options are pricing an increase in volatility in 2Q10. In CDX tranches, spread compression in the underlying CDS caused junior tranches to outperform.
Features
• Assessing the Financial Crisis Responsibility Fee
• I-Spread and Z-Spread adjustment


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