Global CDS Update: The Risk ON Environment

One substantial driver of the direction of interest rates would be the financial market’s perception of credit risks as measured on the credit standings of each nation.

The fierce start of the year rally seen in equity markets have likewise mirrored the actions in Credit Default Swap (CDS) markets

Writes Bespoke Invest (charts their too)

every country except one (Portugal) has seen its default risk decline in 2012. European countries have mostly seen the biggest drops in default risk, with Belgium leading the way with a drop of 31.6%. Greece -- while it still has by far the highest default risk -- has seen its default risk fall the third most in 2012 with a decline of 25.5%. (France ranks second at -25.7%.) The US currently has the lowest default risk out of all the countries shown by a wide margin.

Additional observations

The concerted accelerated massive credit easing programs undertaken by central banks of developed economies has so far soothed or bought off unsustainable debt concerns. Much of the deluge of liquidity apparently has diffused into the global equity and commodity markets through intensified yield chasing actions by market participants.

The easing environment has been complimented by central banks of emerging markets whom has been mostly slashing interest rates too.

The global financial markets have been heavily politicized and greatly relies on sustained central bank support. Given the heavy dependence on central bank steroids, we should expect sharp volatilities in both directions for the marketplace.

I wouldn’t read through the current façade as lasting. That’s because central banks would need further rationalization to pursue current policies. And the only pretext to do more of the same is to see markets undergo spasms anew.

I wouldn’t also interpret the low default risk of the US as sustainable. The US Federal Reserve has been expanding their balance sheet and has been running massive fiscal deficits which means current sanguine conditions are artificial and manipulated and most likely related to the coming US presidential elections.

One interesting observation is that ASEAN CDS are on the lower half of the table and has shown resiliency compared to many major emerging markets contemporaries and even to some developed economies (e.g. France).

If you are counting on a potential ‘decoupling’ by ASEAN relative to developed economies, the CDS markets will likely be the first area to emit such signals. So far, the CDS markets has been manifesting the same dynamics driving other financial markets--the rising tide lifts (almost) all boats.