PIIGS vs. States' USD 5-Year CDS

 |  Includes: ERO, EU, IRL, UDN, UUP
by: Douglas Borthwick

We have talked recently about whether EUR/USD should be looked at as Ireland/California given lately this seems to be the noise around the EUR/USD move. Interestingly, while Ireland contributes only 1% of Europe's GDP, California contributes 13% of the US GDP. The markets are well aware that the Build America Bonds program rolls off at the end of 2010. Before the signing of that program by President Obama, we note the 5Yr USD CDS in California was trading at around 458. Currently, Portugal is trading at 408. This month is seeing a wave of activity in the Municipal market as States scramble to raise money ahead of 2011.

Given the recent change in leadership in the Congress and the ascent of the 'Tea Party,' we doubt whether Congress will extend the Build America Bond plan with any degree of haste. CDS spreads for US States will likely rise considerably above their current levels, at that point eclipsing those of the PIIGS that the market is currently focused on. We also note that current 5-Yr USD CDS indicate Illinois and California have a higher expectation of default than Spain; while Michigan, New Jersey, New York and Nevada have a higher expectation of default than Italy. At some point, given the likelihood of Europe coming to Ireland's rescue, we have high expectations that the States may soon eclipse the PIIGS in terms of default risk. This tipping point will fuel the rally in the EUR versus the USD that we expect going into 2011.

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US States Vs. PIIGS 5-Yr CDSClick to enlarge

Disclosure: No positions