Risk Transfer Has Begun As Germany Net Notional Overtakes Spain

The last two weeks have been full of headlines regarding the volatility and decompression of sovereign spreads around the world. What has been more intriguing to us than day-after-day of discussing Greek 2Y yields or French 5Y CDS has been the relative increases in net notional credit protection outstanding on Germany. The German credit worthiness and sovereignty stands at the heart of any solution to the crises in the Euro-zone and it appears market participants are increasingly pricing in that risk transfer. This is exactly the same transmission we saw in the US when the Fed/TSY announced day-after-day of acronym-laden support mechanisms and shouldered more and more of the private balance sheet risk.

This week, both Brazil and Germany overtook Spain in terms of net notional CDS outstanding with gross notional rising around $670mm on the week for Germany. Interestingly, on the week, Italy and Brazil saw the greatest relative decompression (16% and 10% respectively), but Germany widened 5bps or 6.5% over the course of the week (as Bund yields dropped notably) taking 3rd spot among the Top 5 highest sovereign net notionals.

Data: DTCC


During 2008/9 we saw similar risk transfers in the US and Europe, as evidenced below by the drops in VIX (relative to the USA)


..and VSTOXX relative to Germany protection costs.

Chart: Bloomberg

Of course this time, we start from already elevated levels of risk with greater levels of incumbent balance sheet stress and an investing public who has seen these tricks before and is not as easily persuaded of the magical forces of a politician's or central banker's words.