CDO unwinds to increase index-single name negative basis, says JP Morgan

In research published on Friday, JP Morgan says synthetic CDO risk management should result in dealers buying $150-200 billion protection on single name CDS and selling $75-100 billion index protection. This should keep CDX and iTraxx index basis even more negative, say analysts. JP Morgan expects CDO investors will continue to unwind their positions at a slow but constant pace.

To date, the buying of single name protection by Synthetic CDO risk managers has been more than offset by deleveraging from holders of corporate bonds, leading to increasingly negative bond basis. In 2009, management of synthetic CDO may lead to less negative CDS-cash bond basis.

The maturity of most synthetic CDOs is around 5-7 year. Therefore, JP Morgan expects a greater impact onto the mid and far end of credit curves than on their short end.