Cash-CDS basis has narrowed dramatically, says JP Morgan

JP Morgan says that the average basis between credit default swap and bond spreads has narrowed from 240 basis points in mid-March to 177bp today for investment grade credits. In its Credit derivatives summary and outlook report published on Friday, the bank says the reasons for the narrowing basis in investment grade are investors’ preference for cash credit over derivatives, credit default swap protection buyers resetting positions with the new North American credit default swap trading conventions in greater volume than protection sellers, and modestly improving funding conditions.

The report says that the basis in high yield has also narrowed dramatically – from 600bp to 350bp over the same period. But it says the reasons for the narrowing basis in high yield are different. It says the main reason that high yield bond spreads are rallying relative to credit default swaps is that liquidity is concentrated in bonds.