Tag Archives: Bond market

Greek CDS Blowout: Here We Go Again!

European credit markets underperformed their equity counterparts today, with sovereigns widening ahead of the interim EU summit on Friday. Greece was the main focus this morning after Moody’s surprised the markets with a multi-notch downgrade.

“Greece‘s government called the downgrade “completely unjustified” but the sovereign’s CDS spreads suggest otherwise.”

Gavan Nolan


The agency cut its rating to B1 from Ba1 and left it on negative outlook, citing the country’s large debt burden and the significant implementation risks to structural reform.

Moody’s also raised the possibility of a post-2013 debt restructuring, a view shared by many market participants.

“Greece‘s government called the downgrade “completely unjustified” but the sovereign’s CDS spreads suggest otherwise,” credit analyst Cavan Nolan at Markit writes in Monday’s Intraday Alert.

The deterioration in the country’s credit profile was also reflected in the bond market.

Greece’s 5.9 2022 bond was trading at 66.6 this afternoon, down from 68 yesterday, according to Markit Evaluated Bonds.

The cash market was also placing Portugal’s CDS spreads under pressure.

The sovereign’s 10-year yields hit a wide of 7.5% amid persistent speculation that it will follow Greece and Ireland and accept a bailout in the coming weeks.

A German magazine article today indicated that domestic opposition against extending the EFSF is hardening. But EU commissioner Olli Rehn said today that he is open to the idea of extending the length of Ireland’s loans and reducing the interest rate.

“The divisions within the EU appear to be quite distinct and it won’t be easy to achieve compromise at the next two meetings,” Nolan poins out.

An EU official said today that the bank stress tests are unlikely to include the scenario of a eurozone government default.

“The fact that the last stress tests didn’t evaluate sovereign holdings in banking books was considered a major flaw by many market participants,” Gavan Nolan concludes.

  • Markit iTraxx Europe 102bp (+2.25), Markit iTraxx Crossover 393bp (+6)
  • Markit iTraxx SovX Western Europe 180bp (+2.5)
  • Markit iTraxx Senior Financials 156bp (+3), Markit iTraxx Subordinated Financials 271.5bp (+3.5)
  • Sovereigns – Greece 1030bp (+47), Spain 239bp (+1), Portugal 491bp (+10), Italy 173bp (0), Ireland 577bp (+2), Belgium 162bp (0)
  • Egypt 374bp (+8), Tunisia 193bp (-4), Morocco 185bp (-2), Saudi Arabia 128bp (-4), Bahrain 295bp (-13), Qatar 111bp (-2), Lebanon 3bp (-2), Israel 155bp (-2)

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Smart Money Is Not Stupid (Or Is It?)

The first week of January is often a positive one for risky assets as investors return from their holidays. The pattern looked like it was going to be repeated this week, when spreads tightened on Tuesday, the first full day of trading in 2011. But the credit markets went into reverse on Wednesday. Something doesn’t smell right. The Markit iTraxx SovX Western Europe index soared to a new record wide level of 220 bp’s by Friday’s close, and the peripheral names ended all at,  or near, unprecedented marks.

“It seems likely that there are real fundamental reasons why credit has underperformed this week.”

Gavan Nolan


The senior financials index  broke through 200 basis points on Friday as the investors adjusted to the new reality – that senior debt is no longer sacrosanct. Equities have become accustomed to being wiped out by bailouts, hence the paper had little impact on bank stocks, according to Markit Credit Research. The equity markets are still up on the week, though they have given back some gains Friday.

However:

“It should be pointed out that haircuts under the proposal are a last resort and would not apply to existing bank debt currently in issue,” credit analyst Gavan Nolan at Markit writes in his weekly wrap-up.

But according to Nolan is it likely that this will create a split in the senior bank debt market between outstanding bonds and the new bail-in bonds if and when the plans are implemented. (Probably 2013-2014).

It could also raise the cost of senior unsecured bonds, possibly creating an incentive to issue more covered bonds.

Well, my guess is that the market participants is smelling a rat, and to me that is a sign that fundamentals still rules.  Even if it do not look like it does sometimes. Hopefully, the experienced traders are aware of the fact that a market can stay irrational longer than they can stay solvent.

And it might seem irrational that problems in private financial institutions at the moment, making new funding more difficult and more expensive,  is having a severe impact on the funding of national governments.

But it does.

Spreads in banks based in the euro zone’s periphery continue to hit record levels, particularly those institutions perceived to have weak capital bases, and the turmoil in the bank credit market had a “knock-on effect on sovereign spreads,” Nolan writes.

“Investors are aware that any bail-in mechanism won’t remove the systemic risk surrounding the banking industry, particularly in the near-term.”

You bet they are!

Nor does is seem rational that the stock market is going up while the credit market is going down.

But it does.

Gavan Nolan raises the question if it’s technical or fundamental factors that cause the credit/equity decoupling?

His answer is; probably a combination of both.

“Anecdotal evidence suggests that liquidity in the credit markets is somewhat thin, particularly in single names. Some investors may be deciding to sit out the volatility at this early state in the year, and dealers are reluctant to take on positions going into the weekend,” he writes.

But there has been considerable activity in the indices. (Click here for more details).

“It seems likely that there are real fundamental reasons why credit has underperformed this week,” Nolan concludes.

I’m not quite sure if that is a good thing or a bad thing – probably a combination of both…

Anyway – the perhaps most important publication of the week was the EU consultation paper on bank bailouts.

Newspaper reports emerged on Wednesday suggesting that the EU is planning a framework that will include the possibility of senior bank bondholders sharing the burden of future bailouts.

This led to the Markit iTraxx Senior Financials index threatening to breach the 200 bp’s level for the first time since June 2010.

“The EU paper duly appeared late on Thursday, and the predictable widening effect on spreads followed.”

The Markit iTraxx SovX Western Europe index soared to a new record wide level of 220 bp’s by Friday’s close, and the peripheral names were all at or near unprecedented marks.

But the banking burden isn’t the only force driving sovereign spreads wider:

  • Spain, Italy and Portugal are all due to tap the capital markets for funds next week, commencing what will be a busy period for government issuance.
  • Portugal’s 6-month T-bill auction earlier this week was less than impressive, with yields nearly double that of the previous auction in September.
  • The ECB has been buying Portuguese government debt for the first time this year, and it would be no surprise to see it continue its interventions next week.

Conclution: It seems like the Mr. Ben Bernanke‘s favorite expression “unusual uncertainty” will be valid for at least another year.

PS:

When it come to the co-called “smart money,” I did a Google picture search of the term.

The result was a disturbingly number of Paris Hilton photos.

Now, if that’s supposed to be an illustration of smart money, then God help us all!

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The Pros & Cons of Credit Default Swaps

The CDS market, currently perceived as the most toxic market of all, has existed for nearly 20 years. But most people have only just begun to understand what all the fuzz is about. Said as simple as possible; a CDS is a kind of  insurance a lender buys to secure oneself against a possible default by the borrower. These insurance contracts usually has a maturity period between 1 to 10 years, and usually prized as a percentage of every 10 million units (dollars, euro, yen). A new research paper shred a little more light on this rather unknown market.

“In general, CDS trading has lowered the cost of issuing bonds and enhanced the liquidity in the bond market. Nevertheless, CDS trading has also introduced a new source of risk.”

Ilhyock Shimy/Haibin Zhu


According to the two researchers employed by the Monetary and Economic Department of the Bank for International Settlements, CDS trading has lowered the cost of issuing bonds and enhanced the liquidity in the bond market. The positive impact is stronger for smaller firms, non-…nancial …rms and those fi…rms with higher liquidity in the CDS market, while the negative is that companies included in CDS indices must face higher bond yield spreads than those not included.

The rise and fall of the credit derivatives market is considered the single most important event in the global credit market in the past decade.

Even thou it has existed for nearly 20 years, no one has paid much attention to it.

Until it blew up like an Icelandic volcano in 2008 and covered the whole world with a black cloud of hidden financial risks, that is.

By then the credit derivative market had swollen up to a huge, unmeasurable, uncontrollable market, with an estimated value of more than 60 trillion dollar. Credit-default swaps is one of the most traded credit derivatives, making up almost 90% of the totals.

According to the new research, the notional value of this market have been cut in half since the peak in 2008.

A Short Lesson

By the way – to compare a CDS with a credit insurances is not quite accurate:

A (CDS) is a swap contract and agreement in which the protection buyer of the CDS makes a series of payments (referred to as the spread) to the protection seller and, in exchange, receives a payoff if a credit instrument (typically a bond or loan) experiences a credit event. In fact, it’s a form of reverse trading.

The simplest credit-default swap is a bilateral contract between the buyer and seller of protection. The CDS will refer to a “reference entity” or “reference obligor”, usually a corporation or government.

The reference entity is not a party to the contract. The protection buyer makes quarterly premium payments—the spread —to the protection seller.

If the reference entity defaults, the protection seller pays the buyer the par value of the bond in exchange for physical delivery of the bond, although settlement may also be by cash or auction.

A default is referred to as a “credit event” and include such events as failure to pay, restructuring and bankruptcy.

So, with that out-of-the-way, I’ll go on.

A Double-Edge Sword

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The CDS contracts have been perceived as the main root of all evil in the credit market because of its complex distribution of risk.

The new research paper by Ilhyock Shimy and Haibin Zhu do not confirm, nor dismiss the allegation.

They point, however, to the fact that the CDS market have both positive and negative impact on the financial markets in general.

This is their main findings:

“First, we …find strong evidence that CDS trading is associated with lower cost and higher liquidity for new bond issuance in Asia. This is consistent with the hypothesis that CDS trading helps create new hedging opportunities and improve information transparency for investors. Noticeably, this result is contrary to similar studies based on US data. This contrast provides supporting evidence for our conjecture on the jump-start e¤ect in Asia.

“Second, we …find that the positive impact of CDS trading on the bond market tends to be more remarkable for smaller fi…rms and non-f…nancial …firms. In addition, those …rms with higher liquidity in the CDS market bene…t more in the primary bond market in terms of cost and liquidity.”
“Last, we also …nd that the impact of CDS trading on the bond market is di¤erent during the crisis period. The global …nancial crisis that occurred during the sample period o¤ers a good case study to examine the behaviour of the CDS and bond markets under distress and their linkages. Our analysis shows that, at the peak of the global …nancial crisis, those firms included in CDS indices had to face higher spreads than those not included in CDS indices, above and beyond the general increase in credit spreads observed in the bond market during this period. This suggests that CDS trading could be a double-edged sword: it also introduces new sources of shocks to the bond market.”

Here’s a copy of the full report.

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