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The Sovereign Risk Dislocation Trade Means Big, Black Clouds Coming To "Risk Free"
As early as July, we pointed out the increasingly likely endgame in Europe with regard to the EFSF and centralizing/concentrating credit risk. Well sure enough, sovereign risk has risen dramatically for Germany (among many others obviously) as traders realized standing on the shoulders of giants does nothing but push them further into the dirt. What is becoming more worrisome, and dramatically escalating, is the rise in sovereign CDS relative to government bond yields - or the so-called 'basis' - as it becomes ever more clear that government-bond-yield-by-mandate may not be as 'real' a measure of the risk-free rate as CDS.
Sovereign CDS are denominated in non-local currency - i.e. the spread not only accounts for the chance of technical default but also of a hyperinflationary revaluation of the currency. It is this fact that could make them a far more accurate indication of the real risk in government bond markets - far more so than government bond yields themselves as they remain largely under government or central bank mandate wherever we look.
Charts: Bloomberg
This week saw German CDS pass Bund yields for the first time ever in the 5Y maturity. The 1 week change was over 3 standard deviations - the largest ever! Also notice the Swiss basis jumped when they announced their EUR-peg / implict devaluation 'effort' and how it has pulled back more in line with Germany in the last week or so.
What is notable from the upper chart is the close relationship between US, UK, and German 'CDS - Government Bond Yield' 'Basis'. It seems interestingly coincidental that their bases has tracked each other so closely over the last few years as their government bond yields have varied so differently.
Japan is clearly the most worrisome as CDS appears to price for significantly higher chance of default (or by implication devaluation of the JPY).
China is now starting to catch up the rest of the world after breaking away from it during QE2. China's overnight move in sovereign protection was extreme to say the least - last night's move was well over 3 standard deviations for the CDS alone and the basis jumped dramatically - perhaps the trade of the year will be a China Sovereign basis trade?
The bottom line is that CDS markets potentially offer more insight into the market's perception of 'risk-free' government bond risk (yes we see the irony) as it implicitly reflects both default risk and currency devaluation risk (or in extreme hyperinflation). In an era where governments and central banks spend all day buying back their own debt or managing their own maturity schedule/funding with fiat currency, perhaps following the CDS market is a cleaner way of thinking about 'risk-free' and the basis provides clarity on how much that 'risk-free-ness' is changing.
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So... Deutschmarks are on. Quagmire shortly...
Are you nervous?
http://www.youtube.com/watch?v=5gUcE75KrcY
Well... You could sa... Holy Areola!
Huh? What was I saying? Uhh.. Something abou... Holy Areola!
Need... drink of... water-ola...
...I'll be right back.
Are you cold?
?
I am too busy this morning to be cold... ;-)
Best of luck y'all!
thats why I watch it, no safe places left
A. Economy continues to slow, causing China's economy to also slow, lessining their need to buy UST at the same time that US tax revenue falls and deficit increases causing need for more UST.
B. QE? works economy pics up and sell UST buy Equity.
is it time to short UST?
Thank you.
That explained something I didn't grasp fully.
There is no remaining risk differential. If one nation goes, they all go. Spreads ought to be 0.
I agree. Which leads me to wonder just what the hell I am missing here? The central planners must have something up their sleeve.
Black swans are not seen by the majority operating in the status quo until the swan's beak is firmly on their peckers / other giblets.
Everyone still thinks there's order. We're about to have our Wile E. Coyote moment, when the status quo suddenly looks down and realized the road turned a sharp left about 13 years ago.
Look Out Below.
http://macronomy.blogspot.com/2011/09/curious-case-of-disappearance-of-risk.html
"The recent volatility experienced in August and the continued sell-off in risky assets, suggest something more radical has happened, and what would some people call a game changer."
"Safe havens no longer exist. The game was based on confidence, on risk-free interest rates and fiat-money based on the trust we had in our governments."
"The damages of the debt ceiling debate in the US and the ongoing jitters in the European space surrounding the sovereign debt crisis were both a game changer, in the sense that, it has lead to a global repricing of risk based on a false assumption, namely the existence of risk-free interest rates which the Modern Portfolio Theory is based on."
Martin
Yes... and now we are greeted with further evidence that our CONgress critters are beyond worthless... They are again refusing to raise the debt ceiling. No one told them that as this point it doesn't matter... screwed if they do, screwed if they don't.
Will we have a rerun of the kubuki theater of summer?
Risk free. Right up there with mean reversion in a non-linear system. Its all perfectly normal. But you know what we mean.
Anyone know why CHF is cathing a bid on rumors of the new swap arrangements???? Whats the deal there?
USD is less valuable if they lower the swap rate.
Sieg Heil, bitchez.
Weather for the rest of 2011: Sovereign defaults, mass riots, necessary police brutality and uprisings; wars to follow in 2012, main theatre is rumoured to be the South China Sea.
Have a good day.
SP to 850 in short order -> QE3.1 shortly thereafter -> bull(shit)ish run -> Teh Great Purge
2011 (like 1931)—"The Tragic Year" [Fractal of Events]The year 2011, which politicians and economists were sure would bring recovery, brought instead a far deeper crisis and depression. Hence Dr. Benjamin Anderson's apt term "the tragic year." Particularly dramatic was the financial and economic crisis in Europe which struck in that year. Europe was hit hard partly in reaction to its own previous inflation, partly from inflation induced by our foreign loans and Federal Reserve encouragement and aid, and partly from the high American tariffs which prevented them from selling us goods to pay their debts.
(excerpt from Mises)
The Wisemen who have engineered this crisis are genius in the field of mathematics, where uncertainty is not rampant in such trivial matters as the exponential function: carefully planned, promoted and sold to the public with the sole goal in mind - the collapse of the societies, which were intended to be the target of said Ponzi schemes.
Have a nice genocial Winter, folks!
You mean "Big Black Cow."
On the counter
By your keys
Was a book of numbers
And your remedy
One of these
Surely will screen out your sorrows
But where are you tomorrow?
Move along little people. Move along.
Silver down 8.5%
And of course the CME won't cut the margins...
This is about the most interesting thing you have published.
With US, UK & German CDS prices at what looks like record highs, I'd say the gulf between market perceptions of 'moneyness' & true the quality of government credit a.k.a the gold price, is becoming extreme.
There are no sovereigns. Once we can stomach that fact, the rest of the game becomes rather all too clear.
ORI
Glad to see you're hip to it, ORI.
Yes, this chapter of late 2011 will test the perceptions of what is "Real".
All disbelief was suspended for the last 2 years as one 'miracle' was followed by another 'unicorn', especially in the realm of the miraculous rise of US stocks and miraculous survival of US banks and levered corporations.
The age of 'miracles' seems to be coming to an abrupt and ugly end. The conjurors are out of tricks and their 'magic' no longer seems to impress.
Things are getting all too real
Indeed CE.
And no one (or mostly no one) can bear (bare???) to see their emporer naked!
ORI
lol
Risk free paper money is an oximoron - good to know people are finally waking up... Unfortunately, when people do wake up their 401(k), savings, and the value of every asset class (other than PM and farm land) will be gone... This is going to get very ugly, very fast...
Once even more people realize that the US debt market is insolvent and a true ponzi, after the initial panic and chaos, the market's $ will go back into stocks (the new "risk free" asset is now a high yield dividend stock like LO)...the next coming bull run in PMs and high quality equities will be historically parabolic...the sheeple will be dumbfounded once again....
Tyler,
Could you explain this "Sovereign CDS are denominated in non-local currency - i.e. the spread not only accounts for the chance of technical default but also of a hyperinflationary revaluation of the currency. It is this fact that could make them a far more accurate indication of the real risk in government bond markets" a bit more. In particular, how CDS be denominated in non-local currency makes it reflect a potential hyperinflationary reval of the currency.
Thanks.
I just logged in to thank this particular Tyler for the clear 'Bloomberg-Terminal-For-Dummies' explanations. Appreciated.
**repost, sorry**