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US Treasury Default Risk Now The Same As JCPenney's Was In July

Tyler Durden's picture




 

The cost of protecting against a default on US Treasuries for one-year has surged to 60bps this morning. This is the highest since the Debt-ceiling debacle in 2011 and worse than Lehman. The 1Y cost is the highest relative to the 5Y cost ever.

 

However, many people look at the 60bps and shrug it off as de minimus, after-all, JCPenney trades at 1200bps-plus and is still alive. This is a mistake.

 

The price of protection for US sovereign debt depends on recovery expectations AND the EURUSD exchange rate expectations. Based on current levels, USA CDS imply a 5.9% probability of default - the same as JCPenney in July.

When an entity defaults, the CDS is triggered and an auction takes place to settle the transaction... the buyer of insurance delivers a bond and the seller of protection delivers "par" or 100 cents on the dollar. Therefore the buyer of protection pockets the difference between the cheapest-to-deliver bond and 100.

In the case of US Treasuries, the cheapest to deliver bond is a longer-dated bond trading around $84 (and so that will be in big demand should a technical default occur as protection buyers scramble to lock in their profit.)

 

Also, given that the current premium is 60bps (and it trades in EUR since there would be no protection in USD as the US government could simply print more money to pay its debt and the owner of debt would be unprotected from wealth destruction), which is around 80bps in USD, a recovery of 84c implied a 5.9% chance of US Treasury technical default over the next year.

 

In the case of JCPenney, assuming the standard 40% recovery (which could be worse given Goldman's 1st lien), the US Treasury default rate of 5.9% implies a spread of around 300bps for JCPenney - a level which it was at in July.

The bottom line is that considering 60bps as a small number is a mistake and we hope we have clarified a little about just how concerned investors should be at these levels in this arcane marketplace.

(Note: bear in mind there are a miriad of additional technical details that complicate this analysis further but we hope this gives a sense of the relative scale of a 60bps level for 1Y USA default protection).

 

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Tue, 10/08/2013 - 19:33 | 4036198 One And Only
One And Only's picture

Credit is wrong.

Yellen's appointment is the flag signaling that the debt ceiling has been resolved behind closed doors.

Period. End of story. Move on.

Tue, 10/08/2013 - 19:39 | 4036222 fonzannoon
fonzannoon's picture

It was never unresolved. They were just giving Yellen a good year of QE as a head start.

Tue, 10/08/2013 - 19:43 | 4036232 One And Only
One And Only's picture

Yup.

It's a big show at this point to make Yellen look like a savior.

Congress is an impotent, flaccid, and out of date fixture in American politics at this point.

Tue, 10/08/2013 - 19:46 | 4036250 King_of_simpletons
King_of_simpletons's picture

Stock market from now will move only up, with the move up depending on how big a dump Yellen has taken that morning.

Tue, 10/08/2013 - 20:02 | 4036315 kaiserhoff
kaiserhoff's picture

This might be a fair comparison if:

Jacque C'est Pennya had the power of taxation,

  or if they could print money.

Tue, 10/08/2013 - 19:52 | 4036268 Gringo Viejo
Gringo Viejo's picture

"It ain't much of a crime whackin' a surly bartender".

Augustus McRae

Tue, 10/08/2013 - 20:13 | 4036354 Everybodys All ...
Everybodys All American's picture

What are the chances of a debt downgrade now?

Tue, 10/08/2013 - 19:50 | 4036262 Dr. Engali
Dr. Engali's picture

The only thing the debt ceiling " battle" was ever about is how much room the Bernank needs to print.

Wed, 10/09/2013 - 06:51 | 4037292 Headbanger
Headbanger's picture

You mooks above look really scared!  

Just keep saying "LA LA LA LA LA LA LA.."

There ya go... mooks!

Tue, 10/08/2013 - 19:34 | 4036202 SHEEPFUKKER
SHEEPFUKKER's picture

JC-penny stock

Tue, 10/08/2013 - 19:54 | 4036281 AssFire
AssFire's picture

All things considered, I'll take the flammable polyester self-immobilization suit from JC Pennys over any offer of "help" from my biggest enemy- the federal government.

 

Tue, 10/08/2013 - 19:36 | 4036207 navy62802
navy62802's picture

Yet gold is down. Hmm ...

Tue, 10/08/2013 - 19:36 | 4036211 Muppet Pimp
Muppet Pimp's picture

< Massive Profits life is good

< Massive profits, zimbabwe HI scenario

 

What if the treasury goes out all Paulson style and shorts treasuries all across the spectrum then light the house on fire (defaults)?

Tue, 10/08/2013 - 19:55 | 4036283 Oquities
Oquities's picture

or what if the Fed boosts interest rates by 150%, then buys back Ts and mortages at 50 cents/dollar?

Tue, 10/08/2013 - 23:57 | 4036974 dannyboy
dannyboy's picture

LOL US Treasury does suicide trade on US T-bills. Not even this farce could stoop that low.

 

Could it?

Tue, 10/08/2013 - 19:38 | 4036214 booboo
booboo's picture

Who cares as long as I can still buy my carpenter pants at the U.S. Treasury

Tue, 10/08/2013 - 19:41 | 4036219 ebworthen
ebworthen's picture

No worries.

Generations of unborn children, both here and abroad, will be punished to live under the yoke of Uncle Spam in the future.

If $17 Trillion of unpayable debt isn't a problem, what's another $17 or $34 Trillion?

It will be promises based on military strength and farmland until it doesn't work.

They'll push it and promise and lie until "full faith and credit" is laughed at.

Some politician will say it, and be laughed at.  GAME OVER.

Might take a while, or maybe not; Brussels?

Tue, 10/08/2013 - 19:44 | 4036242 lolmao500
lolmao500's picture

Yellen should start things off by imposing a negative interest rate on saving accounts/checking accounts everywhere in the US to make sure that people SPEND their money! You know, to kick off that recovery!

Tue, 10/08/2013 - 19:50 | 4036261 gafgroocK
gafgroocK's picture

 

 

Whelp, we must be "OK", then!

The wife got 4-5 Credit Card Application from JCP over the summer begging her to sign up and spend.

Tue, 10/08/2013 - 19:51 | 4036267 Oquities
Oquities's picture

let them default.  by the time i get social security in 1.5 years, i expect it will just about pay for my obamacare.

Tue, 10/08/2013 - 19:51 | 4036270 markettime
markettime's picture

(Yawn) Wake me when it is at an 80% chance of default. 

Tue, 10/08/2013 - 20:32 | 4036272 FieldingMellish
FieldingMellish's picture

Last debt ceiling crisis: gold @ $1920

This time: gold @ $1320

 

Despite the introduction of $85b/month of QE since then. Yes, this is all highly rational.

Tue, 10/08/2013 - 19:56 | 4036289 NoWayJose
NoWayJose's picture

Let's see - both the US and JCP are deep in debt, have clueless leaders, are repeating unsuccessful attempts to turn things around, and are not friendly with Martha Stewart... So why shouldn't they be rated the same...

Tue, 10/08/2013 - 19:59 | 4036299 remain calm
remain calm's picture

Being a JCP debt holder I am offended with the comparison

Tue, 10/08/2013 - 20:06 | 4036328 Caracalla
Caracalla's picture

My financial advisor sold me today on buying a bunch of TLT calls on the idea long term yields would drop because of the crisis.  Does this "deal" and Yellen mean I'm screwed, lol?

Tue, 10/08/2013 - 20:44 | 4036460 prains
prains's picture

did you buy some K with your Y?

Tue, 10/08/2013 - 21:25 | 4036588 RSDallas
RSDallas's picture

Tyler,

You have to start editing out the word default. You know damn well there is not going to be a damn default. Help the cause brother!

Tue, 10/08/2013 - 23:11 | 4036885 Wahooo
Wahooo's picture

At least obama's golf course will stay open.

Wed, 10/09/2013 - 00:21 | 4037018 polo007
polo007's picture

http://politicalticker.blogs.cnn.com/2013/10/08/senior-house-gop-source-short-term-debt-ceiling-may-be-way-out/

Washington (CNN) – The door the White House appears to have opened to a short-term debt ceiling increase may be a temporary way out of the standoff, a senior House Republican told CNN.

The Republicans may be willing to go for a short-term debt ceiling increase as long as the president agrees to use that time to negotiate, the source told CNN Chief Congressional Correspondent Dana Bash.

How long is short term?

This GOP source said maybe four to six weeks.

Still, it’s unclear whether Republicans could even get that short-term bill through the House without even a tiny concession on spending cuts from Democrats.

When President Barack Obama was asked during Tuesday's news conference whether he would be open to a short-term debt ceiling increase, he responded “absolutely.”

“I mean, what I've said is that I will talk about anything. What will happen is, we won't agree on everything. I mean, the truth is, is that the parties are pretty divided on a whole bunch of big issues right now," Obama said. "Everybody understands that."

The House GOP source said that the president’s call to Republican House Speaker John Boehner on Tuesday was a good first step – and they have to keep talking.

CNN’s Chief Political Analyst Gloria Borger reported on Saturday that a senior House Republican said one idea being considered is a six-week extension of the continuing resolution to fund the government, and the debt ceiling, to allow for time for both sides to negotiate.

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