Among the prevailing market theories is that the rise in G7 CDS levels is among the main causes for the subdued levels of the VIX which, since November last year, has stopped exhibiting parabolic behavior even on dramatically down days (unable to pierce 60 in the early March market plunge, after breaching 80 when the market hit the higher lows of November 2008). A comparable theory can be applied to credit index levels such as IG11 which did not retrace its November wides by a significant margin.
A convenient way to keep track going forward will be using G7 sovereign CDS indices, which are only gradually starting emerge. Credit Derivatives Research, seeking to capitalize on this unmet informational need, has launched a government risk index which aggregates the sovereign risk of the G7 nations.
The major purpose for this index is presented by Arthur Rosenzweig, CDR president:
“Rapidly increasing budget deficits and debt levels, nationalization of large failing financial institutions, deepening recessions, disproportionate foreign holdings (e.g., by China) and loosening monetary policies have led many investors seriously to consider the possibility of a credit event by one of the major sovereign borrowers, or at least to speculate on their credit quality.”US Treasuries are considered the “no risk” asset in many portfolios and yields on other assets are often quoted in terms of spreads against Treasuries. These securities are also the “go to” asset for banks and governments to hold as reserves. CDS on Treasuries now trade near 70 bps, up from 20 bps last fall. In other words, US sovereign CDS now trade well above where the CDS of the major banks traded at the beginning of the credit crisis two years ago. The current CDS spread levels of the other countries in the GRI are UK 115, Germany 55, France 60, Italy 145, Spain 105 and Japan 90.
As quantitative easing goes full steam over the next several months, sovereign index CDS will likely be the most efficient way to keep track of how the market evaluates the risk to and from the G7 countries, as unprecedented amounts of debt pile into the liability side of the sovereign balance sheet. Zero Hedge expects to see significant moves in sov CDS levels over the next several months, especially as the situation in Eastern and Central Europe hits an inflection point of no return. Sphere: Related Content Print this post