Credit / Equity / Volatility - Looking at this week's divergence

"There is something pagan in me that I cannot shake off. In short, I deny nothing, but doubt everything." - Lord Byron 

This week we have been witnessing a significant widening move in credit over the last few days, not only in the CDS space but also in the cash space, with the basis between cash and CDS remaining stable.

Several primary deals which have been priced aggressively since the beginning of the year are underperforming in the secondary market, generating some selling pressure particularly on investment grade credit in a very thin market, liquidity wise.

At the same time equities are not moving significantly, and both realized volatilities as well as implicit volatilities continue to fall day after day.

Itraxx Main Europe (Investment Grade risk gauge in Europe for 125 entities), Eurostoxx 50 index and Eurostoxx 3 month ATM (At The Money) Implied volatility in the bottom graph - source Bloomberg:

Two possible explanations:

1. Credit is predicting a correction in equities (often the case) and the profit-taking we are seeing will spread to equities.

2. There is a real movement behind this "rotation / re-allocation" from credit / fixed income towards equities, which includes a durable inversion in classical correlations between Credit / Equity / Volatilities.

To be continued...

Stay tuned!