Wednesday, November 5, 2008

CDS Inversion

(FT Alphaville) Credit market investors are indicating they believe the risk of companies defaulting is problem the market will face sooner rather than later.

The curves illustrating the cost of insuring investment grade corporate bonds from default have inverted over the past few weeks, indicating investors in CDS markets are now anticipating default on investment-rated bond defaults could come sooner than previously expected.

Hans Peter Lorenzen at Citi:
A few months ago the perception was that the problems were largely confined to the financial sector and many bank CDS curves were inverted. In recent weeks, however, the market has reassessed the outlook, not just for financials, but for the whole economy. Recession has become the base case (…) that means market expectations of corporate defaults are very front ended. That tends to invert the curve.

October has seen the 5 year CDS spread in the iTraxx Europe index nudge over the 10 year CDS for the first time:

CDS inversion

With recession now a greater fear, the phenomenon is explained one way by investors reconsidering their outlook for non-financial corporates, not just banks.

But a second interpretation could be that the jump in the five year CDS spreads has been caused by jittery investors piling into short dated protection to hedge their positions.
And in spite of the ongoing equity rally, the credit inversion is only increasing.

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