Negative basis 'free lunch' is over, says Goldman Sachs

In its 3 September credit strategy report, Goldman Sachs notes that while going long on the credit default swap-versus-bond negative basis has been profitable, the next leg of normalisation in the financial markets will see liquidity-driven gains slow down.

Strategists are keeping their high-beta negative basis trade open by increasing their stop-gain from 7% to 13%, on grounds that capturing liquidity premia remains attractive. However, fundamental and macro factors will affect returns going forward more than the normalisation of liquidity dislocations and systemic risks.

Gains – albeit smaller – can still be expected. Strategists stipulate that, if normalisation in funding costs and financial stress run their course to reach pre-2007 levels, the remaining upside can be anticipated to be around 80 basis points for investment grade and around 100bp for high-yield.