Deutsche Bank CDS Spike brings Excitement Back to Credit Markets

Deutsche's 5 year subordinated CDS rose to 540 basis points while one year subordinated CDS increased to 552 basis points. This means the Deutsche subordinated CDS curve is decreasing (a pattern of reversion which started appearing in the summer of 2007 during the credit crisis).

Should you wish to trade CDS speculatively there are some electronic trading options. MarketAxess (MKTX) provides a platform for trading single name CDS, CDS indices and index options. For single name CDS, they support streaming prices and a click-and-trade model as well as RFQ model.

Banks stocks sold off and people put money into gold and yen, which is trading at 113 to the dollar, down from a high of 121 yen on the 1st February 2016. The path of gold was slightly skewed as 1st February 2016 was a day of rising gold prices with a peak of $1258 per troy ounce. So whilst gold rose in response to the bank sell-off it was nothing like the peak earlier in the month, which coincided with a sell-off in the S&P.

MS Debt More Risky than Bank of America, says CDS

495 basis points is the highest level it's been in 2.5 years, implying a cost of $495,000 a year to insure $10m of Morgan Stanley bonds for 5 years (more expensive than Bank of America). At 500bps premium, bonds are regarded to have junk status, say Markit. Shares in MS fell 10% to $13.51. The main driver for the concerns is MS' exposure to European bank debt, in particular France.

JP pays $130m for coal trade gone wrong but Blythe remains focused on the bigger picture

JP has been ramping up its commodities business through the purchase of Bear Stearns and RBS Sempra this year. Nevertheless, Chan Bhima and team (ex-Merrill who moved across in 2009) bet on a decline in European coal prices and lost over $100m. Make big bets while you can - get rewarded if you win - else face a public harakiri.

RBS Sempra is an interesting addition to JP's commodity arsenal. They are active in natural gas fixed-for-floating swaps, basis and options. They are the largest non-producer trader of natural gas in North America.

JP also own Henry Bath, which is a metals and soft commodities warehousing company, registered in Liverpool in 1920, but founded in the 18th Century. Henry Bath, from whose name the company hails, found a copper trading business in 1794. Bath & Son developed trade with Chile, exporting coal and importing copper ore and sodium nitrates (Chilean or Peru saltpetre) which was used in fertilizer and gunpowder. The 1850s was the era of coffee-shop deals, which evolved formally into the London Metal Exchange, of which H. Bath was a founding member.

Blythe Masters is the illustrious Head of Commodities at JP Morgan and helped JP develop CDS in the 1990s.

CDS Curve Inversion

Probability of short-term default higher believed higher as CDS curves for Greece, Spain, Portugal have inverted as has BP CDS. Exposure to Greece for French banks is highest with Credit Agricole, through its ownership of Emporiki, and SocGen, which owns Geniki Bank. The Guardian quotes James Rickards, former general counsel of LTCM, on the morality of CDS - "Why should we have instruments where the hope is for the failure of a sovereign state?".

Eurozone Concerns: Bafin's Ban and its Implications for the FX and the Eurozone

Euro setting new lows, falling further (1.2163) as Germany bans short-selling - reason given was bond volatility and also widening of credit spreads. Bafin's (German regulator) doesn't German firms in the UK (e.g. Deutsche Bank London won't be affected according to the WSJ).

But what did the short-selling ban really mean? It covered shares, mainly of financial companies (e.g. Allianz), but not futures or long puts (arguably insurance, rather than short-selling). It also covered naked short-selling of euro-zone country debt, and naked sovereign CDS for Eurozone i.e. not for hedging of default risk.

Note to the curious: the Ba in BaFin stands for Bundesanstalt (Federal Agency) and Fin stands for Finanzdienstleistungsaufsicht (Finanicial Services Supervision).

Greece Downgraded by Fitch, Yields on GBonds Rise!

In Dec09, Fitch (shortly followed by S&P) downgraded Greece's credit rating to BBB+ with negative outlook (the first time in 10 years the country has received a sub-A rating, though still investment grade). Moody's was left with the only A1 rating on Greece's debt. This is a great case study in how the market reacts to a ratings downgrade. Actions: Athens shares fell 6% in response. CMA reported Greece 5yr CDS rose to 226.8 BPS from 209 BPS on Tuesday's NY close (a rise of 17.8bps). 10 yr Greek government bonds fell, yields rose to 5.4%. This also caused the Greek-German 10yr bond yield spread to widen by 4bps to 225bps. Also the Greek finance minister issued mutliple reassurances: "Papaconstantinou (PhD LSE, worked previously at OECD) says Greek banking system not at risk". (STOCKS, BONDS, CREDIT, BOND SPREADS).

Why the concern? What drove the downgrade? The reason is Greece's high levels of debt (forecasted to be 125% of GDP next year). A downgrade is bad for a country - it may make it difficult for the country to raise money in bond markets and through central bank liquidity operations (e.g. through ECB, exchanging sovereign bonds for ECB loans).

Public Sector Borrowing and its impact on FX rates and CDS prices

GBPEUR

In the FX markets, December saw the GBP trading at parity with the EUR, its worst performance yet this year but a price target predicted by analysts in a self-fulfilling prophecy. Alastair Darling's remarks earlier in the year accelerate the sell-off.

GBPUSD

In July sterling was trading at $2, then dwindled to $1.50. Why? Partly Britain's public finances - the Treasury's pre-Budget report forecast UK public borrowing will rise to £78bn for 2008-09 and then to £118bn in 2009-10 (8% of GDP). These figures though are not consistent with data from the ONS.

Analysts point out a high level of government borrowing tends to spell trouble for sterling. A post-war high was reached in 1974-75 (6.9% of GDP), which led to Britain asking the IMF for emergency funding in 1976. The Treasury's counter is that it believes the recession will be shallow and brief. The UK has been running a deficit since 2002/2003.

The CDS market for sovereign debt has indicated the cost of insuring default by the Treasury on its gilts over 5 years has reached 100bps over Libor (7.2 bps a year ago). Analysts CEBR announced (speaking about the recession across Europe): "The United Kingdom economy is likely to be the hardest hit by the credit crunch due to its reliance on consumer borrowing and the financial sector for growth".

But who is trading in the sovereign CDS market and why? BoA research provides some answers.