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Which Nations Are Next? The Credit Market Answers

Tyler Durden's picture





 

The debate about the usefulness of sovereign credit default swaps (SCDS) intensified with the outbreak of sovereign debt stress in the euro area. SCDS can be used to protect investors against losses on sovereign debt arising from so-called credit events such as default or debt restructuring.

Although CDS that reference sovereign credits are only a small part of the sovereign debt market ($3 trillion notional SCDS outstanding at end-June 2012, compared with $50 trillion of total government debt outstanding at end-2011), their importance has been growing rapidly. With the growing influence of SCDS, questions have arisen about whether speculative use of SCDS contracts could be destabilizing - and this caused regulators to ban non-hedge-related protection buying.

The prohibition is based on the view that, in extreme market conditions, such short selling could push sovereign bond prices into a downward spiral, which would lead to disorderly markets and systemic risks, and hence sharply raise the issuance costs of the underlying sovereigns. The IMF's empirical results do not support many of the negative perceptions about SCDS. In particular, spreads of both SCDS and sovereign bonds reflect economic fundamentals, and other relevant market factors, in a similar fashion. Relative to bond spreads, SCDS spreads tend to reveal new information more rapidly during periods of stress, admittedly with overshoots one way or the other. Given the current apparent 'stability' in many nations' bond market spreads, the chart below suggests an alternative way of judging what the credit market thinks - the volume of protection bid - and in this case some interesting names emerge.

Do Sovereign CDS Lead or Lag - the answer is both...

The Hasbrouck statistic shows whether SCDS or sovereign bond markets move faster to incorporate news: when the statistic is higher than 0.5, SCDS lead the price discovery process; otherwise, bonds lead. Statistics are estimated from a panel vector error correction model using rolling two-year windows of daily data. Resulting series are smoothed using a one-month moving average.

The chart below shows at what times SCDS lead and what times bonds have lead...

 

Vertical lines indicate events related to the global financial and sovereign debt crisis (upper panel) and to the EU's ban on naked short sales of SCDS instruments (lower panel) as follows:

  1. Bear Stearns collapse (March 14, 2008).
  2. Lehman Brothers bankruptcy (September 15, 2008).
  3. EU debt crisis intensifies in October 2010 ahead of Ireland’s financial aid request.
  4. European Commission consultation on short selling (June 14, 2010).
  5. European Commission short selling regulation proposed, banning naked short sales and SCDS protection sales (September 15, 2010).
  6. European Parliament adopts short selling regulation (November 15, 2011).
  7. Final Version of EU short selling regulation published (March 24, 2012).
  8. EU short-selling regulation becomes effective (November 1, 2012).

But since the ban, most notional amounts have been reduced - as the regulators forced 'speculators' or some might call 'price discoverers' out of the market - leaving behind only those who have 'legitimate' need for hedging. There is one stand-out - Italy! Italy notional hedges remain as high as ever...

And so while prices may be manipulated or managed or smoothed - thanks to insatiable demand from domestic pension funds and banks who can re-collateralize for free money at the ECB, there is another 'signal'. Instead of purely the relative prices (or spreads) of the CDS market, it is perhaps more useful to judge just how much of the sovereign bond market is being hedged as a measure of the market's fear of a restructuring event...

As is clear above, the relationship between credit rating (perhaps an independent measure of sovereign riskiness) and the outstanding CDS protection relative to the bond market is quite tight. There are a few outliers - Greece (private holdings are low and no official sector will 'hedge'), Egypt/Argentina/Venezuela (highliughted in green - have been in trouble for months/years and hedgers have largely unwound profitable hedges or have unwound the underlying exposure since these markets are priced for the event already. The most obvious standouts are where the hedgers hold a massive amount of protection relative to the nations' bond market (highlighted in red). These include Latvia, Hungary, Peru, Panama, and Ukraine.

Finally, of the world's so-called advanced economies, New Zealand stands out in a worrying manner - is this a second derivative, highly convex cheap bet of China's collapse?

 

Charts: IMF

 


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Sun, 04/14/2013 - 19:30 | Link to Comment Stuck on Zero
Stuck on Zero's picture

Clearly, from the last chart, if the U.S. falls from a AA+ to BB- or worse it will look like Argentina.

 

Sun, 04/14/2013 - 20:12 | Link to Comment Fredo Corleone
Fredo Corleone's picture

"New Zealand stands out in a worrying manner..."

Timely, these Kiwi central bankers:

http://www.nzherald.co.nz/business/news/article.cfm?c_id=3&objectid=1087...

Sun, 04/14/2013 - 20:44 | Link to Comment DoChenRollingBearing
DoChenRollingBearing's picture

Ah, I note that Peru does not look so good above at rating "BBB").  Maybe their bond investors are a bunch of chickens?  The Peruvian sol ended the week unchanged (granted, that is short-term data if I have ever seen it).

US corporate bonds did not get a glowing review from Barron's columnist Michael Aneiro...

"Review of Barron's -- Dated April 15, 2013"

http://tinyurl.com/ctt2sdu

***

And now back to what I really want to do: watch PM prices...  Currently gold is up about $2.00, platinum down about $2.00 and silver up nine cents -- all essentially unchanged.  

Hmm.  I was kind of expecting more fireworks...

 

Sun, 04/14/2013 - 20:52 | Link to Comment Pure Evil
Pure Evil's picture

I think if you slide the right hand scale in a downward trajectory in the last graph where the 'CC' rating lines up with the United States we might actually get a clearer picture as to where everyone relates to everyone else.

Did you hear the story about the Emperor's new clothes?

Gather round kiddies I have a whale of a tale to tell!

Mon, 04/15/2013 - 07:58 | Link to Comment misitu
misitu's picture

That worried me somewhat until I noted the date of the chart... a lot has happened, including in Peru, in two years.

A good thing about this country is it seems to be under the radar generally. Which suits me fine.

Sun, 04/14/2013 - 22:59 | Link to Comment Dry Drunk
Dry Drunk's picture

The People's Utopia of New Zealand is a freaking Socialist nightmare. The mid-2000s brought back the welfare monster that bankrupted the country in the early 1980s. Red Tape suffocates the land.

Yet hiding behind the govt placing the non-productive morons at the top of society, and the productive man at the bottom, is the corporate extraction of product without value added (why make profits in the high tax region?). The whole country is asleep and has never questioned the third-world extraction model that is run in all of NZ's ag and primary production. NZ never made it developed country status. Rio Tinto was recently shaking down the govt for subsidies for an Aluminum plant (white elephant) that uses 15% of the country's electricity.

$28 Billion in govt debt in July 2008, and now $78 Billion -- which country has done worse?

Sun, 04/14/2013 - 20:47 | Link to Comment zorba THE GREEK
zorba THE GREEK's picture

Everyone is next, only the order is yet to be determined. Events will

pick up speed and at some point in the near future, it won't matter

who is next because there won't be time to address each problem 

before the next one appears. I will be surprised if we make it to 2014

before a major event causes bank holidays worldwide.

Sun, 04/14/2013 - 23:44 | Link to Comment johngaltfla
johngaltfla's picture

The Neo-Marxists are determining who is next. Capitalism as we know it has died except in Galt's Gulch. Herr Merkel is busy deciding where to invade with her Panzer Banksters next....

 

Marxist Merkel leads Germany’s new Push to Destroy Capitalism in Europe
Sun, 04/14/2013 - 23:01 | Link to Comment Paul Bogdanich
Paul Bogdanich's picture

This is plain stupid.  The Russians don't issue the CDS isntruments on their bonds we do.  Nor would they honor any potential claim on any assets owned or un-owned based on our CDS obligations.  So in that sense all those CDS obligations should be classified under the countries that originated them and where the counterparties are meaning we and the Brits own like 95% of them.  So who has the liability?  The Russians look at our CDS instruments as playthings of an out of control Bourgeoise and could care less. 

Mon, 04/15/2013 - 05:00 | Link to Comment GenXer
GenXer's picture

NZ Prime Minister looking to push through greater rules to spy on it's citizens. Looks like they are starting to get the tools in place for when the economy hits the wall.

http://www.stuff.co.nz/national/politics/8552746/Sweeping-GCSB-changes-a...

Sun, 04/14/2013 - 19:34 | Link to Comment Dr.
Dr.'s picture

New Zealand on the way to become New Iceland? The opposite of Greece can't be that bad ;-)

Sun, 04/14/2013 - 19:40 | Link to Comment LawsofPhysics
LawsofPhysics's picture

Yes, this is exactly it.  One of my brothers lives there now.  The grow all their own food, export many things that come from sheep and have geothermal and coal.  There welfare system is pretty fucked, but at the present time there are still about 4 million more sheep than people.  Beautiful country.

Sun, 04/14/2013 - 19:59 | Link to Comment Matt
Matt's picture

No deposit insurance in New Zealand, it seems.

Sun, 04/14/2013 - 19:44 | Link to Comment Yen Cross
Yen Cross's picture

   Witch/which Nations are next. South America, Sub. Saharan Africa comes to mind.

Sun, 04/14/2013 - 19:44 | Link to Comment Schmuck Raker
Schmuck Raker's picture

"...New Zealand...is this a second derivative, highly convex cheap bet of China's collapse?"

Way to go Tylers, you outed Hugh Henry's trade.

Sun, 04/14/2013 - 19:59 | Link to Comment YC2
YC2's picture

Neat!

Sun, 04/14/2013 - 20:09 | Link to Comment disabledvet
disabledvet's picture

You might want to define "collapse" first. Comparing China and New Zealand is absolutely ridiculous...as lovely as I am told (by people close to me) New Zealand is. China is sitting on TRILLIONS in US treasury debt. China is the worlds second largest economy (absolutely crushing the EU right now.) China is a manufacturing and technological powerhouse. China (so far) has a "special relationship" with the USA. Don't get me wrong...I'm not moving anytime soon...but if that euro zone breaks apart China might not be the cause but it sure is a major "contributing" factor. Obviously I no longer think but KNOW "Germany gets it." clearly the world...and in particular the USA has an EPIC learning curve...should be interesting to see "the catch up."

Sun, 04/14/2013 - 20:19 | Link to Comment YC2
YC2's picture

It's not a comparison, it's a second derivative

Sun, 04/14/2013 - 23:52 | Link to Comment Schmuck Raker
Schmuck Raker's picture

The more of your claptrap I read the more I respect veterans whose disabilities are NOT self induced.

Mon, 04/15/2013 - 01:56 | Link to Comment Rogue Trooper
Rogue Trooper's picture

Agreed, some people read a considerable amount yet fail to comprehend.

An example of 'Cognitive Dissonance'?

Sun, 04/14/2013 - 19:48 | Link to Comment Downtoolong
Downtoolong's picture

Goldman set me up with and SCDS for Greece. My counterparty is the Central Bank Of Cyprus. But don’t worry, it’s also guaranteed by AIG.

Sun, 04/14/2013 - 21:56 | Link to Comment FinalCollapse
FinalCollapse's picture

Watch "Muppet Show" before going to sleep. All is well.  :-)

Mon, 04/15/2013 - 02:00 | Link to Comment Rogue Trooper
Rogue Trooper's picture

How about Barney? Or is that too intellectual?

I, for one, feel that the Teletubbies marked the moment of complete decline from which there is no recovery.

Sun, 04/14/2013 - 20:13 | Link to Comment Sziget
Sziget's picture

Hungary will come crumbling down soon i can tell you. We have a nicely building dictatorship, a total moron was appointed to head the central bank from the party's nest lately. Who keeps his one eye on the printing presses for long time. His new plan is to give 0% interest loans to banks so they can loan to small and middle sized businesses. And he calls that "unorhodox" method. Oh and if u didn't know these nice guys confiscated all private pension accounts 2 years ago and they have already spent it all on the budget hole the flat 16% income tax hit. Which also made rich more richer and poor more poorer. Nice perspecive right?

Sun, 04/14/2013 - 21:28 | Link to Comment dvfco
dvfco's picture

That's a joke about the United States, no?  I think it was you just making sure to throw in a twist or two by saying 'retirement accounts seized two years ago' rather than 'retirement accounts will all be seized within the next two years.'  Then, you'd have the US of A summarized perfectly.  Growing dictatorship migh have to be amended to nearly perfected dictatorship ever since John Roberts turned the Supreme Court over to the Executive Branch.

Sun, 04/14/2013 - 22:02 | Link to Comment FinalCollapse
FinalCollapse's picture

Dictatorship, moron heading the Central Bank, printing money like crazy, unorthodox (waco) economic theories, (plans to) seize the retirement accounts - that sounds like something close to home, no? 

Sun, 04/14/2013 - 22:58 | Link to Comment q99x2
q99x2's picture

As the FEDs lose the ability to bribe the states, the states will be inclined to secede. They won't be receiving Federal benefits but instead liabilities. That won't last long.

Sun, 04/14/2013 - 20:31 | Link to Comment All is chosen
All is chosen's picture

Is it only me that can't see the septic isle (UK) on the last chart?

Maybe it is miles ahead? (like the jazz album)

Sun, 04/14/2013 - 21:33 | Link to Comment andrewp111
andrewp111's picture

There are a whole lot of unlabeled points on the bottom row.

Sun, 04/14/2013 - 20:45 | Link to Comment Lux Fiat
Lux Fiat's picture

Interesting observation on New Zealand.  Would be interesting to see the data on Australia as well, particularly to see if it is confirming.  Would expect both to be in somewhat similar boats. 

Sun, 04/14/2013 - 21:29 | Link to Comment munts
munts's picture

ok please share: how could one trade this convexity and under what conditions would the trade work?

Mon, 04/15/2013 - 00:24 | Link to Comment mc_LDN
mc_LDN's picture

It surely makes sense to bet large against Australia first given they are exposed on mining / energy on a China collapse. NZ is joint to this exposure by nature of the large amount of trade done with both Australia and China.

Mon, 04/15/2013 - 01:58 | Link to Comment Lux Fiat
Lux Fiat's picture

Hahahahaha! 

I could get back to you after I go look up "convexity" on Investopedia and check out the Australian and NZ bonds on Bloomberg's public site, but something tells me it would be a waste of time on both ends.

Regards,

a simple technical trader 

Sun, 04/14/2013 - 20:50 | Link to Comment exartizo
exartizo's picture

Since the advent of manipulated markets by governments smoothing in all forms has supplanted the rule of law and economic principles almost without exception.

The ONLY type of event that has not been effectively controlled (with enough time and whatever required government intervention) are those that are completely unpredictable.

Predictable events such as the collapse of the Euro and other currencies, the collapse of systemically critical markets, and sovereigns have been smoothed via MSM, CB's and other government intervention to infinity to give all relevant parties enough time to remove at risk assets.

This is the primary goal.

To give all wealthy parties enough TIME to adjust to changing market conditions completely amerliorates the final risks that have not been governmentally controlled for and smoothed.

In this way, the proverbial "can kicking" can be prolonged virtually indefinitely in the absence of unpredictable events.

It is only an unpredictable event that can sufficiently destabilize and collapse the Ponzi before restabilization and smoothing via MSM, governments and CB's can respond.

"Unpredictable events" efectively defines their "achilles heel".

Sun, 04/14/2013 - 20:54 | Link to Comment Yen Cross
Yen Cross's picture

   exartizo  That was a very well written response. +1  

   I'll dissect your point's upon request.

Sun, 04/14/2013 - 21:00 | Link to Comment exartizo
exartizo's picture

Feel free my friend.

Cheers

Sun, 04/14/2013 - 21:12 | Link to Comment exartizo
exartizo's picture

The Most Unpredictable Event Of All Time will be:

The Return of The Lord Jesus Christ.

Sun, 04/14/2013 - 22:41 | Link to Comment Unique Snowflake
Unique Snowflake's picture

Seriously!?

This is what makes religious people dangerous. Not just the countless murders committed in the name of their particular skypixie, but that they make real world decisions that affect everyone, based on their own personal preposterous belief system.

Unless of course your comment was irony a it's finest...then I salute you sir.

Mon, 04/15/2013 - 02:37 | Link to Comment ronaldawg
ronaldawg's picture

Deus Caritas Est.

The communists and socialists have killed more in the past 200 years that the Christian church ever has.  And the socialists will continue killing as we are about to see in real time. 

It seems that the Christian church has learned the lessons of history.  I would put my faith in the new pope rather than the big gummit types like Communist In Chief OBAMA.

 

Mon, 04/15/2013 - 03:30 | Link to Comment TrulyBelieving
TrulyBelieving's picture

I suppose you have your own personel preposterous belief system?

Mon, 04/15/2013 - 08:03 | Link to Comment Random
Random's picture

Close but not really. Not the Christians (as individuals) have killed countless number of people, the Church did it. There is a bit of a difference, as instances when crazed mobs killed innocent people (on account of their faith, or lack thereof) are rare and insignificant compared to the systematic killing of people done by the Church (and oddly enough, in Europe, the slaughtered ones were...drum roll...Christians).

You might want to get off your high horse of atheism and anti-christian rhetoric and check the facts.

Regarding decisions based on personal belief system, i could turn around and tell you that your beliefs are most likely also dangerous for others, but i won't say it.

Cheers!

Mon, 04/15/2013 - 10:00 | Link to Comment TruthHunter
TruthHunter's picture

Christ's return: the ultimate Deus ex Machina...

He said He was coming back.

 

True, religious people are dangerous, but hardly more so than Stalin, Pol Pot, Mao, and Hitler...

As for "own personal preposterous belief system." believing in the efficacy of little numbered pieces of paper(or pretty PGM's for that matter) rates pretty well.

Sun, 04/14/2013 - 23:34 | Link to Comment prains
prains's picture

Or the Return of the Sith Lord but I fear he has already arrived and resides in the house of cheney

Sun, 04/14/2013 - 23:54 | Link to Comment savagegoose
savagegoose's picture

o god protect me from these religious nuts

Mon, 04/15/2013 - 01:20 | Link to Comment Notarocketscientist
Notarocketscientist's picture

It's predictable - George Carlin says so http://www.youtube.com/watch?v=gPOfurmrjxo

Mon, 04/15/2013 - 02:29 | Link to Comment Satan
Satan's picture

...lol...

Sun, 04/14/2013 - 20:59 | Link to Comment Mr. Hudson
Mr. Hudson's picture

The bigger question is this: The collapse of which country brings down the whole world?

Sun, 04/14/2013 - 21:44 | Link to Comment trebuchet
trebuchet's picture

1. that volume could be related to  or driving the Hausbrook stat lead-lag results  ( not sure whether research done on this)

 

Sun, 04/14/2013 - 22:10 | Link to Comment Clowns on Acid
Clowns on Acid's picture

Do charts that afr based on historicial data have any value at all in todays centrally comntrolled markets?

The Fed prints fiat and buys bonds and equities and slams paper gold. Illegal and immoral.

How can historical charts reflect this behavior ? Time for Congress to begin debating charges to be brought against the Fed.

Sun, 04/14/2013 - 23:23 | Link to Comment Kirk2NCC1701
Kirk2NCC1701's picture

Request that Tyler provide names of unnamed blue countries in lower left.

Mon, 04/15/2013 - 00:18 | Link to Comment Slipmeanother
Slipmeanother's picture

Japan will be the trigger

Mon, 04/15/2013 - 00:23 | Link to Comment mc_LDN
mc_LDN's picture

It surely makes sense to bet large against Australia first given they are exposed on mining / energy on a China collapse. NZ is joint to this exposure by nature of the large amount of trade done with both Australia and China.

Mon, 04/15/2013 - 01:34 | Link to Comment skip90291
skip90291's picture

Excellent comment, Dry Drunk. I am relieved New Zealand's precarious position is FINALLY starting to come to the surface. It has been below the radar too long. We relocated here from the US and we have smelled a rat since we arrived. I have never seen a populace so over-extended on real estate. The true economy seems non-existent. Everyone is mortgaged into 2, 3, 4 or more houses, but no one has a real income. All the money seems to get sucked out of the country overseas. All the major banks are foreign owned. The people we meet are broke, broke, broke. This is a poor farming country that has pretended to be soemthing else based on credit--borrowed money to get off the tractor and into a Range Rover. but the truth will come out. Talk about a house of cards! I am afraid for New Zealanders.

Mon, 04/15/2013 - 01:34 | Link to Comment skip90291
skip90291's picture

Excellent comment, Dry Drunk. I am relieved New Zealand's precarious position is FINALLY starting to come to the surface. It has been below the radar too long. We relocated here from the US and we have smelled a rat since we arrived. I have never seen a populace so over-extended on real estate. The true economy seems non-existent. Everyone is mortgaged into 2, 3, 4 or more houses, but no one has a real income. All the money seems to get sucked out of the country overseas. All the major banks are foreign owned. The people we meet are broke, broke, broke. This is a poor farming country that has pretended to be soemthing else based on credit--borrowed money to get off the tractor and into a Range Rover. but the truth will come out. Talk about a house of cards! I am afraid for New Zealanders.

Mon, 04/15/2013 - 02:28 | Link to Comment Tompooz
Tompooz's picture

For all investing migrants who were thinking of moving to NZ, news of a potential collapse (of the Govt bond market? of the Real Estate market? the stock market?) must be music to their ears. Arriving in a new country during an economic bust, makes investment in cheaper Real assets that much more attractive; makes contractors that much easier to negotiate with, good employees  that much easier to find.

It may sound cruel to broke overindebted Kiwis, but they only have to give a little twist to the immigration spigot and ..hey presto, the binge can resume .

Mon, 04/15/2013 - 02:40 | Link to Comment ronaldawg
ronaldawg's picture

I'm waiting for France.

Mon, 04/15/2013 - 04:01 | Link to Comment ebworthen
ebworthen's picture

"With the growing influence of SCDS, questions have arisen about whether speculative use of SCDS contracts could be destabilizing..."

Really?

Is gambling destabilizing for the gambler's wallet?

Is a 777's machine good for a person's bank account?

Why does anyone wonder whether or not Credit Default Swap speculation (gambling) is destabilizing or not?

It's like saying North Korea launching a nuclear missle is good because it will cause profits for the military/industrial complex.

Mon, 04/15/2013 - 04:10 | Link to Comment icm63
icm63's picture

The forecast for Aussie is SAD, then its double bad for NZ..

 

http://www.readtheticker.com/Pages/Blog1.aspx?65tf=958_australia-to-ente...

Mon, 04/15/2013 - 06:25 | Link to Comment yourfather
yourfather's picture

In the book this time is different, the statistics show s&p ratings arent goodleading  indicators of an impending credit or bank crisis.

 

Deregulation of the sector is more likely to cause a crisis.

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