What CDS Speculators? The Reason Why Greek Spreads Blew Up Is Because Of Bond Selling, Not CDS Buying

Tyler Durden's picture

There is nothing quite as liberating as jumping on the bandwagon of scapegoating that which one does not understand. The idiocy of the chorus which blames CDS "speculators" for the mysterious kidnapping and rape of the Easter Bunny and Santa Claus' stomach stapling, not to mention the imminent Greek implosion (NOT as a function of a funding crisis, but due to the one soon to be unending strike, which will commence once Greeks realize their wages are about to be cut by 250% and the new retirement age will the same as that of Yoda), is just getting surreal. And if the cheap seats housing the portly derrieres of all those CDS "experts" need yet more proof just how full of excrement their pointless multi-syllabic exhortations are, we present Credit Trader's very diplomatic presentation (diplomatic, because our version would have included a preponderance of breathless f-bombs, which is why we wisely decided against writing one), which is sufficient and necessary to hopefully shut all these empty chatterboxes up for good. Alas, that ain't happening. Either way, here is the data, which will certainly not make an impression on anyone except those why actually do understand how the CDS market works. For everyone else (the "it's like selling a warehouse full of feces... in backwardation, thank you speculators... buying crap insurance on the warehouse and then redirecting the Chipotle lunch hour crowd into it" people), start writing your disgruntled, opinionated and Thesaurus-worthy retorts. Oh, and by the way, are speculators guilty that CDS spreads on Greece have collapsed by over 120 bps in the past two weeks? Oddly, we have not heard anything about that at all in the idiotstream media.

Here's an idea - how about clamping down on all those idiot money, mutual funds who bought GGBs at 15 bps over Bunds and now can't wait to sell enough (leaving for the moment that they did so based on flawed macroeconomic data, courtesy of a Greek FinMin which materially misrepresented the country's GDP and interest payments).

Rant over. Here is Credit Trader.

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.

From CreditTrader