Fear Drives CDS to All-Time Wides, World-Wide

I’d like to say the only thing to fear is fear itself. But given that CDS are what has fueled most of the financial crisis, perhaps a more timely saying might be “The only thing to fear is credit default swaps”?

The first two lines of a note by Markit’s Miles Johnson says it all:

Credit default swap spreads spiralled wider worldwide on Wednesday as low volumes and bearish sentiment drove the cost of both sovereign and corporate default protection to unprecedented highs.

The Markit iTraxx indices for European investment grade and junk debt jumped to new records while cds written on the debt of the UK, US, Italy, France, Spain and Germany were at all-time high levels.

(remember that “wider” means that the credit default swap traders consider the risk of the referenced entity failing are greater).

The following chart from one of the leading trackers of CDS – Credit Derivatives Research – shows the story on global CDS over the last year:

(click here if you can’t see the last move up).

As one example of soaring sovereign default risk, the above-quoted noted by Johnson says:

The cost of protecting against default by the United Kingdom now stands at 105 basis points, up from a close of 99bp on Tuesday….To truly comprehend the explosion in the UK’s CDS spreads one just has to remember that at the start of February 2008 five-year contracts were trading at a respectable 8bp.

An article by Markit’s Stacy-Marie Ishmael notes that fear of unprecedented levels of corporate defaults is driving corporate bond CDS through the roof:

But the CDS market isn’t the only one pricing in some form of economic and financial Armageddon.

The current spread between junk-rated bonds and Treasuries implies a US default rate of 21 per cent, higher than the record set during the Great Depression in 1933, John Lonski, chief economist at Moody ’s Investors Services, told Bloomberg televison.

And an article on Bloomberg regarding credit default swaps notes that fear of a depression is what is driving CDS to new highs:

The cost of protecting corporate debt from default jumped to a record in Europe and neared a high in the U.S. amid concern that the global recession will sink into a depression.***

“Markets are pricing somewhere between a recession and a depression, and that is what we are faced with,” said Philip Gisdakis, a Munich-based credit strategist at UniCredit SpA, Italy’s biggest bank. “We are already in a recession. The next economic phase will not be recession, but depression.”.

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