The Mystery of Sovereign Spread Widening November 23, 2009 at 5:58 pm
|
FT alphaville picks up some research from Paribas on sovereign CDS spreads. The claim is that spread widening in the peripheral EU countries are being driven by ECB policy:
Certainly ECB action could cause a weakening in demand for certain government bonds as the ability to finance them cheaply and earn carry disappears. Spreads are definitely widening, as the illustration shows. (This story would be a little more compelling if we could see the historical spreads for Greece, Poland, Slovakia etc., but it is safe to assume that these have blown out too.) Is this all ECB driven? |
 |
|---|---|
 |
I suspect not. In particular there is a popular credit derivatives product which packages up a leveraged sovereign CDS in a note. Essentially the buyer of the note gets an enhanced return in exchange for selling CDS on a multiple of their notional at risk. The catch with these products is that they do not just trigger on an ordinary credit event: in order to protect the selling bank, they also trigger on spread widening. Thus for instance on popular version of the product in 2008 year paid Libor plus 1% or so in exchange for seven times leveraged exposure on Spain, with a trigger if the Spanish sovereign CDS spread hit 100 – a level it is perilously close to today. These notes are reasonably subtle products in that they can seem to the naive like simple speculations on sovereign default – and no one expects Spain to default. But the spread trigger means that they are in fact rather sophisticated forms of credit spread option. The note issuers hedge by selling sovereign CDS on the other side. All else being equal, this should act as a brake on spread widening, as note buyers take advantage of better spreads to sell more CDS. |
But who are the buyers of sovereign CDS on the other side of this and other trades? There is much less pressure to do negative basis trades on government bonds as there is little regulatory capital advantage. So what puzzles me about the spread action is who is paying these high prices to buy sovereign protection, especially on the better quality names. That is the real answer to the spread widening puzzle.
David,
Not sure how related, but…
Recent action with respect to Greek yield spreads leads me to believe that general opinion has migrated from ‘everybody is going down’ to ‘we’re all saved’ and now to looking at individual cases on their merits. The stickiness of the Spanish case is probably another example as is the recent worried look of Italian govs.
Rightly or wrongly, fear of contagion has disappeared.
Cheers
I think you are right – although this is all filtered through the usual capital markets spectacles, hence the bizarre idea that Greece as an EU member is nearly as risky as Turkey…
It’s a little hard to figure why anyone would want to short Greek bonds. The last case of this, in March, was put an end to by the BCE implying that no one was going to be allowed to go down.
Has something changed that I don’t know about?
[...] For me the glaringly good one is Greek sovereign CDS: as Ibex Salad pointed out in a comment on my previous post on spread widening, from a fundamental perspective, this looks like money for old rope. Yes, spreads could widen [...]
[...] Original post: Deus Ex Macchiato » The Mystery of Sovereign Spread Widening [...]
Hola, mi nombre es Sabrina y estube buscando por internet, fue entonces que encontre tu blog, el cual me gusto mucho, el cual es bastante agradable para leer. Regreso la proxima semana para leerte de nuevo. Saludos Sabrina