Bloomberg News

Germany Default Swaps Lower as Haven Bid Fuels Bonds Distortion

July 20, 2012

The cost of insuring against default on German government debt tumbled to the lowest level since April this week as investors sought to profit from a dislocation between the nation’s bonds and credit-default swaps.

Debt protection contracts on Germany plunged to as low as 72 basis points on July 17 and were at 74.5 basis points as of 11:22 a.m. in London, from 84 a week ago, according to prices compiled by Bloomberg. They were the most-traded swaps globally in the week ending July 13, Depository Trust & Clearing Corp. data show.

Investors seeking a haven from the sovereign debt crisis are snapping up bonds of the safest European governments, in some cases paying to lend to nations such as Germany and Finland. Some investors are choosing to sell default insurance instead of buying securities that yield less than zero, according to Jochen Felsenheimer, a managing director at Assenagon Credit Management in Munich.

“It definitely makes sense to sell protection on Germany,” said Felsenheimer. “CDS is paying more and there are some accounts that are trying to sell protection rather than buying bonds. However that’s still a rather limited part of the market.”

Sovereign Risk

Germany’s two-year note yield fell to minus 0.074 percent on July 18 and was minus 0.64 percent today, while Austrian, Swiss and Finnish rates turned negative this week for the first time.

The Markit iTraxx SovX Western Europe Index of credit- default swaps on 15 governments dropped to 259 basis points this week, the lowest level since the series started trading in March, before rising 1.4 basis points to 263 today, Bloomberg prices show. A decline signals an improvement in investors’ perceptions of credit quality.

The cost of insuring corporate and financial debt increased, paring weekly declines.

The Markit iTraxx Crossover Index of 50 European companies with mostly high-yield credit ratings rose two basis points to 644, up from yesterday’s two-week low. The Markit iTraxx Europe Index of 125 companies with investment-grade ratings climbed one basis point to 162.

The Markit iTraxx Financial Index linked to senior debt of 25 banks and insurers rose one basis point to 272.5 and the subordinated index increased one basis point to 443.

A basis point on a credit-default swap protecting 10 million euros ($12.2 million) of debt for five years is equivalent to 1,000 euros a year. Swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements.

To contact the reporter on this story: Abigail Moses in London at Amoses5@bloomberg.net

To contact the editor responsible for this story: Paul Armstrong at Parmstrong10@bloomberg.net


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