USA - CDS Spreads Higher than Mexico

Bloomberg:

Trading of credit-default swaps insuring U.S. Treasuries has doubled as the government struggles to agree on plans to cut its budget deficitand raise the $14.3 trillion national debt limit.

A total of 819 contracts covering a net notional $4 billion of debt were outstanding as of May 20, up from 449 contracts covering $2 billion a year ago, according to the Depository Trust & Clearing Corp. Average daily trading volume surged to $490 million last week from $10 million the week before, making the U.S. the fourth most active among 1,000 contracts tracked by DTCC, up from 633rd.

Swaps insuring Treasuries for five years are trading at 50 basis points, according to CMA. That compares with 37 basis points in April and a record 100 basis points at the peak of the financial crisis in 2009. One-year contracts are now more expensive than Panama, the Philippines and Mexico, CMA prices show.

Anyone else see the humor here?

Higher Capital - Different Risks

From Bloomberg:

Trading desks of big Wall Street banks, grappling with higher capital requirements, may decide to boost their holdings of emerging market securities and sovereign debt, according to Brad Hintz at Sanford C. Bernstein & Co. 

The so-called Basel III capital requirements imposed by the Basel Committee on Banking Supervision as well as limits to proprietary trading and changes to derivatives rules in the U.S.'s Dodd-Frank law make it harder for trading desks to earn a sufficient return on equity, Hintz wrote in a note to investors today. One solution will be changing the types of assets held on trading desks, Hintz said in the note. 

"Our belief is that the 'new optimal' balance sheet of Wall Street will include larger emerging market positions in equity and debt" because they are fast growing and earn a higher return, Hintz wrote. Banks will also emphasize "a large government and sovereign book" because such holdings require little capital even if they earn low returns, he wrote. 

Such a shift by Wall Street's biggest firms, which include JPMorgan Chase & Co., Goldman Sachs Group Inc., Morgan Stanley and Citigroup Inc., has potential risks if emerging market equities and bonds as well as sovereign debt lose value.

Two things:  The irony of potentially pushing banks into different risk markets has not eluded me.  Second, see my earlier post on EM - it looks heady here.  Admittedly, this would not happen overnight (for those with their finger on the BUY button) and I still believe that there are better, lower entry points ahead.

Goldie Recommends an EM Exit Visa

(Bloomberg) Goldman Sachs Group Inc. recommended closing out its suggested bet that emerging market stocks will outperform the Standard & Poor’s 500 Index, citing improving U.S. economic data and inflation in developing nations.  Investors should close positions that benefit from outperformance of the iShares MSCI Emerging Markets Index Fund over the S&P 500 with a potential profit of 2.3 percent, Goldman Sachs strategists said in a note to clients.

“The near-term outlook for this type of relative trade versus the U.S. is more muddied than it has been for some time,” the report said. Equities in emerging markets “should remain broadly well-supported, but after a strong run since September, it will be important to be more selective going forward.”

The Goldman analysts cited improving American jobs data and faster-than-estimated growth in the Institute for Supply Management’s index of U.S. service industries as reasons to exit the trade now, as well as inflation and policy tightening being “back squarely on the emerging-market policy agenda.” 

Just a thought here, what will happen to EM debt should policy tightening and inflation jump back into EM?  Perhaps its time to take some of this risk off the table or ensure you are not over exposed.  Or maybe you could say "at least I am not in Ireland or Greece", but will this help the pain when the EM risk trade reverses?

I am not saying unwind because Goldman said so (which could possibly mean they are a buyer), but perhaps a conversation on the subject is warranted.

Yeah, this isn't your father's debt returns!

Emerging Market Credit - One Sided Trade

Bloomberg:

The yield gap between junk-rated company bonds and investment-grade debt in emerging markets is near the smallest since June 2008 as less creditworthy borrowers benefit most from cash pouring into developing countries.

The spread has narrowed to 225 basis points, or 2.25 percentage points, from this year’s high of 314 basis points on June 8 amid a worldwide rally in corporate bonds. The gap reached 217 on Oct. 15, a 28-month low and the smallest since before Lehman Brothers Holdings Inc. collapsed.

JPMorgan Investment Grade Corporate Emerging Market Bond Index (yield):

Setting up for an intermediate term short.  The risk trade seems to be one sided - never a good bet.  Yes, there is momentum and yes, there will be blood.