Steep curves offer equity tranche opportunity, says Morgan Stanley

Record steep curves in credit default swaps provides a good opportunity to go long longer-dated credit, according to a report from Morgan Stanley (The Credit Curve Conundrum). The bank's analysts note that curves have tended to steepen lately irrespective of whether the market is tightening or widening.

According to the report, the current steepness reflects the lack of a natural long dated risk taker in credit. It does not reflect fundamentals, say the researchers: either curves should be flatter or, if the steepness is justified, then the spreads across the board should be wider.

The report suggests that equity tranches are a good way to take advantage of the steepness, either by selling protection on long-dated equity outright or by going short equity tranches at the short end and selling protection at the longer end.