The Great Debate UK

What message is the CDS market sending us?


By Laurence Copeland. The opinions expressed are his own.

Not many people seem to have noticed, but something almost unthinkable has happened in the Credit Default Swap (CDS) market recently. It is now one point cheaper to insure against a default by Her Majesty’s Government than by the Federal Republic of Germany. Given that only a few months ago, Markit was quoting twice as much to insure against a default on gilts as on bunds, this is a major change – but what is it telling us?

The message is unclear, but my guess is it is not quite the one which Britain’s Chancellor, quite reasonably from his point of view, would have us believe. Yes, the market has faith in our ability and willingness to repay – but that is far from the whole story.

The hint is in the fact that Japan (with its enormous government debt, even before it gets very far with post-tsunami reconstruction) and post-downgrade USA also have low CDS rates. As I have pointed out many times before in these blogs, what we have in common with Japan and America, apart from rockbottom government bond yields and associated low CDS rates, is the freedom to print our own currency. The fact that the three of us have massive debt burdens is therefore regarded as irrelevant. By contrast, this freedom is denied to euro zone countries, who are supposed to repay debt out of government revenue, which makes their creditworthiness dependent on their ability to collect tax and their prospective future growth rates which will determine the size of their tax base. Although Germany has a reasonably modest debt-to-GDP ratio, it cannot straightforwardly print money to repay its creditors. Add to that the fact that the market is finally waking up to the realisation that Germany is coming under heavy pressure to shoulder the debt of the rest of the euro zone, and its debt level suddenly seems far less modest.

It is often said that the markets can only concentrate on one thing at a time, which seems strange – but how else to interpret the current state of affairs? How else can one explain the willingness of the market to lend unlimited amounts to America even though the Fed has made it plain that it will carry on printing money until inflation revives and the dollar gets even weaker? It certainly makes sense for investors to ignore the negligible risk of a CDS-triggering default by Britain or America – but leaving aside CDS rates, even if outright default is ruled out, why would anyone want to buy five-year gilts or U.S. Treasuries at yields of barely 1 percent?

Post stress tests: lending conditions likely to remain tough


SnipImage-Jane Foley is research director at The opinions expressed are her own.-

The financial markets have been pre-occupied with all aspects of the EU bank stress tests over the past few weeks.
For the man on the street, however, the debate boils down to just one question: when will credit become cheaper and more readily available?