The big story for 2010: sovereign debt worries?

Happy New Year.

Over the past couple of weeks, the cost of buying protection to insure against a default by the UK government has risen to exceed the cost of insuring a basket of European investment grade companies.  The chart shows that 5 year Credit Default Swaps (CDS) for the UK sovereign are currently at 83bps per year, compared with 72 bps for the investment grade companies, which are all lower rated than Her Majesty’s government and unlike the UK, the last time I looked weren’t allowed to print bank notes to repay their debt.  So it doesn’t look right.  But noises about a downgrade of the UK continue, and the plans from both the government and the opposition to reduce the debt remain unconvincing.

Elsewhere we’ve had sovereign debt scares in Dubai and in Greece, and yesterday in Iceland the President exceptionally overruled the legislature and stopped a payment to the UK and the Netherlands of £3.4 billion to cover money lost by savers in the Icelandic banks.  Fitch downgraded Iceland to BB+ yesterday, although the bigger agencies still have the country in investment grade, but only just.  Iceland CDS now trades at 470 bps.  The decision by the Icelandic people isn’t surprising, as the payment amounts to around £10,000 per person – a massive burden.  I can’t imagine that UK voters would agree to make such a payment to a foreign government should the table be turned, and the Icelandic economy is in a worse state than ours.  This article in today’s Irish Independent by David McWilliams is therefore a little worrying, as it probably does reflect the popular view that default is a better option that a strong credit rating or than having to wear a hair-shirt for a decade.  Ireland has entered into significant austerity measures (including large pay cuts for civil servants) in order to restore the nation’s finances.  McWilliams concludes “Iceland proves there is an alternative – are any (Irish) politicians, from the President down, prepared to listen?”.  2010 could be a year of angry populations and wobbly governments.

The value of investments will fluctuate, which will cause prices to fall as well as rise and you may not get back the original amount you invested. Past performance is not a guide to future performance.

Discuss Article

  1. Anonymous says:

    Broadly agree with your bond vigilantes piece on sovereign debt – but take slight issue with your exact comparison of levels – given cds is denominated in USD's for GBP sovereign and the very act of a UK govt downgrade would impact the currency, the mkt attempts to price that into the cds level, where as a corp cds even if it is denominated in USD would have minimal currency impact if it downgraded and so mkt doesn't adjust in same way…it’s a similar logic to why you can't compare the exact level of gilt yields with the level of uk govt cds and say one is wrong or they don't equate mathematically as given the currency difference of each you are not comparing like with like, so while the concept is definitely correct here too its very hard to define the extent to which one misprices vs the other as you have to make currency move assumptions.

    Posted on: 06/01/10 | 12:00 am
  2. Paul Brown says:

    This sounds very similar to when football clubs preferred to go into administration and start again than suffer onerous. The authorities realised that they had to be punished and took 10-20 points of them making relegation more likley.

    If downgrading (relegation) isn't good enough should more of a penalty apply.

    Perhaps UK non membership of the euro was the masterstroke of its generation, at least we can print our way out.

    Posted on: 14/01/10 | 12:00 am
  3. Anonymous says:

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    Posted on: 01/03/10 | 12:00 am

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