Utilities have been hit too hard in the US credit derivatives market, and traders should position for the credits to recover, according to JPMorgan Chase & Co. strategists.
(Bloomberg) — Utilities have been hit too hard in the US credit derivatives market, and traders should position for the credits to recover, according to JPMorgan Chase & Co. strategists.
The cost of protecting a basket of utility credits against default has risen by 11 basis points this month, or 0.11 percentage point, to 89 basis points, the strategists wrote. Meanwhile, The price of protecting the wider market, as measured by the Markit CDX North American Investment Grade Index, has only risen 1 basis point to 74 basis points.
Utilities are getting hit in the credit derivatives market in part because their equities are dropping, which in turn may stem from rising interest rates hitting their cost of capital, according to JPMorgan strategists including Saul Doctor and Dmytro Shelukhin. But the firm’s North American utilities analysts believe the cost of capital will mainly have an impact on growth rates for the companies, and have less of an influence on credit quality.
The strategists recommend selling five-year credit default swaps, or CDS, on a basket of utilities, while buying protection on the broader five-year CDX.IG index, a trade that can generate positive returns if utilities outperform the market.
“We believe an equity driven widening in CDS spreads on the back of this development coupled with the relatively robust performance of the sector in cash markets suggests the recent widening in Utilities CDS is overdone,” the strategists wrote.
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