Chart of the Day: U.S. Sovereign Weirdness

by: Felix Salmon
Click to enlarge chart

This chart comes from A Credit Trader, who has a long and very useful blog entry on the subject of US sovereign CDS. He basically gives the simple answer to my question of "who on earth is buying protection at these levels": it's people who think that the spread is going to widen out. So far, people making that trade have made a lot of money, so there's a good chance that the simple answer here is the right one.

He provides this chart as an example that there are all manner of weirdnesses in the capital markets right now. It shows the yield of 30-year swaps (the blue line) and 30-year Treasuries (the red line); right now, Treasuries (which are risk-free AAA securities) are yielding more than swaps (which carry a double-A credit risk). Now one way of looking at this chart is to say that the market now reckons that Treasuries are not risk-free, and that in fact they carry more credit risk than swaps. But as ACT explains, that's basically an incorrect explanation: the correct explanation is something much more boring and technical to do with the flattening of the swap curve.

Similarly, ACT is convinced that technical factors probably underlie the widening out in US sovereign CDS spreads: they're illiquid at the best of times, and they're really only following the rest of the CDS market in gapping out.

But there's no doubt that if you want a single datapoint demonstrating how weird the markets are right now, the US CDS spreads in triple digits are a very good one to use. It doesn't say much about the safety or otherwise of Treasury bonds, but it does say a lot about the usefulness of looking to the CDS markets as an indicator of anything much.