Growing worries over the credit-worthiness of sovereign debt have nicked the safe-haven appeal of US Treasuries just as the government plans to sell $99 billion in securities next week. The cost to hedge against a US government debt default rose on Friday to its highest since January, while its borrowing costs are hovering at their lowest in five months.
--- 5-year CDS highest since January; 1-year CDS jump
--- Benchmark yields hover at 5-month lows before auctions
"All sovereign risk is rising and we're facing the rising tide floating all boats effect," David Keeble, global head of interest rates strategy with Credit Agricole Corporate and Investment Bank in New York, said on Friday. In the sovereign credit default market, which is small and mainly used by speculators, the five-year cost to protect against a US Treasury default was last quoted at 51.167 basis points, up from 48.401 Thursday, according to Markit.
The five-year Treasury CDS was at its highest since late January when it reached 51.443 basis points. The one-year protection cost on US obligations jumped 15 basis points on the day to 40 basis points, analysts said. Worries persist over Washington's struggle to reach a deficit-cutting deal and to raise its $14.3 trillion legal borrowing limit, which was hit on Monday.
If the debt ceiling is not raised by August 2, the Treasury Department may run out of manoeuvres to avoid skipping interest payments on US obligations. Although the amount of Treasury debt affected will be small, such a move could rattle investor confidence in holding US government securities.
Last month, Standard & Poor's revised down its outlook on the United States, raising the risk it may drop its prized AAA-rating if Washington does not make substantial cuts to the deficit. While the United States' debt predicament is troublesome, it is in comparatively better shape than Greece, Spain and other weaker members of the euro zone, analysts said.
Anxiety over all sovereign credit-worthiness has been manifested in a rise in credit default swaps on the government debt of Japan and European countries as they face their own fiscal problems. "It's a general disdain against these sovereign problems. Those problems are not going away," said Chris Ahrens, interest rate strategist at UBS in Stamford, Connecticut.
The five-year cost to insure against a Greek default was quoted at 1,226.409 basis points, up 4 percent on the week, while the five-year CDS price on Japanese government debt was last quoted at 82.678 basis points, up 1 percent from a week earlier, according to Markit.
Even German Bunds, which are seen as the safest sovereign debt by some investors, could not escape the upswing in CDS prices. The five-year price to insure them was last quoted at 24.108 basis points, up 4 percent on the week. Most analysts downplayed the rise in US CDS as any kind of sign that investors fear the United States will become insolvent. Instead they see the move driven by speculative bets on whether the Treasury will miss interest payments, which would constitute a "technical" default, if US lawmakers do not increase the debt ceiling by the August deadline, they said. A technical default would trigger payments to CDS holders.
"People are looking for cheap ways to play the US political fears and if the US were to technically default somehow you could get paid a lot," said Ira Jersey, interest rate strategist at Credit Suisse in New York. If the Treasury were to miss interest payments, the CDS holder could be paid the face value of the credit default contract and deliver cheapest US debt to the CDS insurer.
But any market impact stemming from CDS positions will likely be limited, analysts said. There are $3.9 billion worth of US CDS outstanding, which is a fraction of the trillions in government debt in the market, according to the Depository Trust and Clearing Corp. Despite the higher US CDS prices, UBS' Ahrens expects the US Treasury Department will have little trouble selling next week's supply of two-year, five-year and seven-year notes.
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