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Credit Check -- The European Edition

Fil Zucchi

Good morning from Rome, Italy, where the weather is almost as hot as the US markets. And by that I do not mean equities, I mean corporate bonds.

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Despite yesterday's sharp spike in Treasuries, which is showing up again in the MOVE Index (the Treasury equivalent of the Volatility Index (INDEXCBOE:VIX) ), the thirst for everything corporates continues. As I write this, credit default swaps (CDSs) of large US financials are holding the uber-sharp July pullback. The same can be said of broader high-yield (HY) CDSs, even though their July gains were far more muted. HY spreads jumped from 490bps to 700bps from mid-May to mid-June, dove back down to 575bps, and seem to have found a comfort area around 600-610bps. I call it "comfort area" because that's certainly where bond buyers and sellers seem to be content to do business, to the tune of $30 billion of new issuance in just the last five trading days, and $117 billion in the last 18 days. So when someone tells you about the iShares HY ETF (HYG) falling hard and folks running away from HY debt, you may want to point out to them that where the rubber of bond sellers meets the road of bond buyers, the heat of passion is melting both.

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Other derivatives such as the two-year swaps (USSP2) and the US CDSs are also giving the green light to "risk on," or more accurately perhaps, they are giving some serious agita to the macro bears. If that were not enough, CDSs of foreign financials such as Banco Santander (SAN) and Deutsche Bank (DB) are creeping toward 52-week lows, or in the case of BNP Paribas (OTCMKTS:BNPQY) and Allianz (OTCMKTS:AZSEY), actually making new year lows. Spanish and Italian CDSs are also going along for the ride south.

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With equities making new highs seemingly every day, buyers are getting more and more squeamish and/or fearful that the inevitable air pocket is just ahead. Reasonable enough, but as was the case for SanDisk (SNDK), which plunged 16% in six days, don't be surprised if those drops are met by CFOs throwing the kitchen sink at debt-funded buybacks (17% of float in SNDK case) and ripping the faces off the bears just as they were getting comfy. That's the dynamic of this equity bull and will remain so until the corporate bond market shuts down for good. Considering collateralized debt obligations (CDOs)/collateralized loan obligations (CLOs) offerings are on pace to double from last year and banks are securitizing residential rents, the appropriate topic for discussion should be around how large the tsunami of money into corporates will grow, rather than when the bond market will close.

Happy Trading! And while I continue my vacation, see me on Twitter: @FZucchi

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