European Debt Chaos Sends Chills Through Credit Markets

A bundle of negative news caused the sovereigns to continue to underperform on Monday, compared to the broader market. The difference between the Markit iTraxx SovX Western Europe and the Markit iTraxx Europe is now over 60bp, a new record. Ireland’s CDS spreads are back up above the 500bp level, close to an all-time-high.

“Bondholders could now face interest holidays and haircuts on their sovereign holdings.”

Gavan Nolan


Heightened concerns over the peripheral euro zone sovereigns helped temper any gains from better than expected economic leading indicators. The EU agreement last Friday, driven by Germany, which “bails-in” bondholders has shaken the sovereign debt markets.

“Bondholders could now face interest holidays and haircuts on their sovereign holdings,” credit analyst Gavan Nolan writes in today’s Markit Intraday Alert.

“The consensus in the market seems to be that the permanent restructuring mechanism will be implemented after the EFSF expires in three years time,” Gavan points out.

Adding that this was not the only factor pushing sovereign spreads wider.

“A plethora of stories emerged over the weekend that did nothing to help sentiment.”

The negative news flow ranged from peripheral banks increased dependence on ECB funding; an article in the Irish Independent suggesting that Ireland could be forced in the hands of the IMF if the upcoming budget isn’t approved.

Greece’s deputy prime minister made another hilarious attempt to reassure the world that “everything is fine” ny  stating that “demonizing debt restructuring is wrong”.

“The swathe of negative news led to sovereigns continuing to underperform the broader market; even Portugal‘s two main parties reaching a compromise on the budget had negligible positive effect,” Gavan Nolan at Markit comments.

The basis between the Markit iTraxx SovX Western Europe and the Markit iTraxx Europe is now over 60bp, a new record.

Ireland’s spreads are  back above the 500bp level, close to a historic all-time-high.

“The sovereign situation had a dampening effect on a market becalmed by European holidays,” Nolan notes.

Leading indicators produced by Markit and the ISM pointed towards a global economy in recovery.

The Markit/HSBC China Manufacturing PMI came in better than expected, and the expansion was driven by domestic demand rather than the usual exports.

Here’s a copy of the report.

In contrast, however, the consensus beating Markit/CIPS UK Manufacturing PMI was underpinned by growth in exports.

According to Markit is this an “encouraging sign” for the British coalition government.

Monday afternoon day the ISM manufacturing survey came in higher than expectations, but with little impact on the credit markets in Europe.

The Ghost of Crisis Past

Remember the monoliner Ambac?

One of the worlds largest isurers of corporate debt (including financial companies) that was on the edge of collapse in the middle of the 2008-turmoil – an event that could have caused even greater pain than Lehman Brothers did.

Well, now Ambac seems to be in trouble again.

The insurance company reportedly skipped a $2.8 million bond payment today in contemplation of a potential bankruptcy filing; the company believes the move will provide leverage in negotiation with creditors towards a prepack filing; the payment has a 30 day grace period.

Complicating a potential restructuring are: $7 billion in earlier operating losses which has a tax benefit for future income as long as there is not a change of control and Ambac’s operating subsidiary which is under the auspices of the Wisconsin courts and the Wisconsin insurance regulator.

According to Markit, Ambac’s 5-years CDS is now at 75 basis points ($7.5 million upfront + $500,000 running per annum on $10 million notional).

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