ABS Protection Buying Kick Starts

Investors in synthetic asset-backed securities have reacted to a slowdown in the U.S. housing market by starting to buy ABS protection. "We are starting to see people go short [the underlying] for the first time," said one ABS trader, who noted as a result of the move spreads on BBB minus securities have rallied more than 20 basis points over the past two weeks.

The trader said CDS on low-grade ABS is returning around 150 bps, which is roughly 100 bps more than low-grade corporate CDS. This, combined with the sustained rally in corporate CDS spreads, had this year spurned massive demand from collateralized debt obligation buyers for long positions in the equity slices of ABS CDOs. "Hedge funds had money to invest and they demanded long and leverage," said another ABS official.

Recent remarks from U.S. Federal Reserve chairman Ben Bernanke that the housing market has lost altitude, however, come on top of data confirming a cooling. This has led the change in tactics by ABS CDS investors.