Thursday, March 25, 2010
Three stories from the Wall Street Journal hint at bad news for the U.S.
Michael Casey notes that American CDS traders view the U.S. as riskier than Europe:
Something troubling has occurred in the market for default protection on the debt of the world's biggest borrower.
As the folks at Standard Poor's Valuation and Risk Strategies division noted in a research note Monday, the difference between the spread on U.S. sovereign credit default swaps and an equivalent benchmark for AAA-rated euro-zone sovereigns flipped into positive territory March 12. As U.S. CDS spreads expanded to their widest levels in two years, that cross-region gap blew out to 5.7 basis points last Friday before narrowing to 4.7 Tuesday.
Wider CDS spreads indicate that sellers of insurance against a particular issuer's default are charging more for it. In effect, the positive U.S.-versus-euro zone spread means investors think the risk of a U.S. default--however remote--is greater than that on euro-denominated sovereign debt.
So much for the view that low inflation and loose monetary policy make for a rosier debt outlook for Treasurys than for the debt of crisis-hit euro-zone sovereigns.
"We've seen CDS on U.S. Treasurys break with euro CDS before, but never to the degree we have here," said Michael Thompson, head of research for S&P's Valuation and Risk Strategies group. "If we sit on this precipice for a time, I think a lot of market participants would see this as a bit of a shot across the bow, a bit of a wakeup" for anyone who's complacent about U.S. debt.
Wouldn't it also challenge U.S. Treasurys' status as the so-called "risk free" benchmark? S&P didn't go there. But the report did say the trend "reflects increasing market anxiety surrounding the U.S.'s credit quality." In other words, a fiscal deficit worth 10% of gross domestic product--in the absence of a clear plan to reduce it -- matters.
Short-term moves of a basis point or two can be attributed to technical factors, but such a lasting shift in the two regions' CDS relationship "is not technical," Mr. Thompson said. "I certainly wouldn't ignore it."
Thompson's team also noted that the deterioration in U.S. default swaps meant that S&P's "market-derived signal" dropped to 'aa+,' its lowest level in two years. The historical series for that indicator is based on an established correlation with actual S&P ratings.
There's no indication that S&P's separate ratings division is about to downgrade the U.S. 's vital 'AAA' rating. But over time, ratings analysts cannot stay blind to market signals like this one. As its weighs the stimulus needs of a still-fragile U.S. economy against future risks to debt servicing costs, the U.S. government can't ignore market signals either.
Deborah Blumberg documents lousy treasury auctions:
Treasury prices fell hard after a poor five-year auction that escalated concerns about the government's ability to sell its massive amounts of debt.
Worries about supply picked up this week after the government's $44 billion two-year auction on Tuesday attracted less demand than anticipated. The five year sale was messier, sending Treasury prices tumbling. Demand at the auctions may have been impacted by less buying from Japan as its fiscal year-end approaches. Nonetheless, the poor results put investors on edge given the huge amounts of debt the government is likely to continue to issue to fund its budget deficit.
Investors were reminded of the huge amounts of debt the government will need to continue to sell after President Barack Obama signed into law a $940 billion health-care overhaul bill on Tuesday, which will necessitate even more borrowing by the government.
"We're going to continue to see massive amounts of supply in Treasury-land," said Brian Edmonds, head of interest rates at Cantor Fitzgerald & Co. in New York.
It was an "ugly auction," said Ward McCarthy, managing director of the fixed-income division at Jefferies & Co. "You're starting to see a bit of a Treasury market protest. There's a very legitimate concern that Washington is pushing the envelope too far in terms of the U.S.'s ability to carry all this debt."
And Tom Lauricella and Mark Gongloff add:
Some observers fear that the market is finally starting to show the strain of absorbing a record flood of new Treasury issuance. One sign of that could be the unusual crossing of swap rates below Treasury yields, which could signal that investors see corporate debt as safer than Treasury debt.
"This is a first sign of stress leading to higher Treasury yields and is not to be missed," James Caron, head of U.S. interest-rate strategy at Morgan Stanley, said in a note to clients.