Citi recommends El Paso for short bond play

Citi says there are good opportunities in buying short-dated corporate bonds. In its most recent High Yield Weekly report, it points out that while credit default swap curves have steepened dramatically over the past six months, those for cash bonds have not steepened to the same extent.

It suggests buying the 7.857% 2012 bonds of El Paso at a price equivalent to a z-spread of 355 basis points. Buyers can then hedge by buying protection at the same maturity for 180bp for a gain of 175bp.

Part of the reason for the difference in credit default swap and cash curves is that the treasury yield curve is so steep, which depressed the yields on shorter dated bonds. As the report points out, total return investors have little incentive to buy a two-year bond yielding just 5%. But it suggests that spread-oriented investors can take advantage of the opportunity, particularly in crossover names, with El Paso an obvious candidate.

The report recommends hedging the El Paso basis trade with treasuries in case a withdrawal of liquidity from the financial system causes spread tightening.