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The last two days have seen notable compression in sovereign spreads globally as rumors come and go on the short-term solution for Greece et al.
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The last two days have seen notable compression in sovereign spreads globally as rumors come and go on the short-term solution for Greece et al.
These three charts might be useful for getting some perspective:
Chart 1) The first chart compares the 5Y GGB to the 5Y CDS (both relative to Germany). Clearly in AUG08, GGBs led the weakness and CDS followed as GGBs remained major underperformers. CDS actually led the rally back in Q1 2009. In NOV09, CDS started to leak wider first but very quickly GGBs caught up and until the last few weeks have tracked perfectly with higher beta moves. Since the Jan 26th GGB issue, Greek 5Y CDS has actually compressed (red arrow) while GGBs have continued to widen in spread.
Chart 2) shows the GGB-CDS basis for the 5Y and 10Y maturity. Once again this is adjusted for Germany (i.e GGB is spread over Bunds and CDS is greek CDS over Germany CDS). The most notable thing is that the basis is negative and in 5Y getting more negative - this means that 5Y GGBs trade with higher risk premia than 5Y CDS (which seems odd given speculators were apparently responsible for this damage). This negative basis (bonds underperforming CDS) has continued since the new issue in Jan for 5Y but in 10Y has stabilized. This is atypical behavior as is clear from the chart and we suspect is driven by derisking from the longer-dated segment of the curve in preparation for the new 10Y issue.
Chart 3) really exaggerates this point as we have seen GGB 5s10s continue to invert since that Jan new issue as the GGB term structure flattens up notably in the short-end and inverts even greater the longer-end. This suggests an implicit expansion of spread duration in GGBs (which may help explain the basis movement differences). This is opposed to the CDS 5s10s curve which has steepened notably since the Jan new issue - almost perfectly balancing the apparent risk appetite in longer-dated GGBs.
The pull-back in risk in Greece is notable but remains extremely elevated.
The term structure of yields is basically flat from 12 months out and the term structure of credit is considerably inverted in GGBs.
It should be clear from these charts that CDS were not the driver of risk up or down but held their somewhat barometer-like relationship to cash quite healthily.
The inversion/flattening of the GGB 5s10s curve and steepening of the CDS 5s10s curve suggest a derisking among smarter money into the pending 10Y auction while slower money can see 10Y GGB yields drop as it appears the 'worst' is over.
We suggest otherwise and that the derisking will lead to decent demand for the 10Y issue but at very wide concessions - bulls will point to the B2C being high but realists will see a major concession as indicative of a true risk premium.
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