Rates: A market deader than LIBOR? US sovereign CDS
admin | January 7, 2020
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Does a market quote mean anything if there are virtually zero transactions in the underlying product? The 5-year US credit default swap spread – which putatively reflects the cost of insuring against a technical or fundamental default on US Treasury securities – has declined from a high of about 60 bp in 2011 to 15 bp today. However, there haven’t been any meaningful new trades of US sovereign credit default swaps since January 2014, and the number of outstanding contracts has shrunk from over 1,500 to less than 200 over the time period, according to researchers at the New York Fed. The majority of transactions that have occurred in the US sovereign CDS market since 2014 have been assignments of existing contracts, which simply redistributes the credit exposure among counterparties in the financial system. Despite the moribund transaction market, the researchers point out that academic interest and analysis of US sovereign CDS quoted spreads has increased. Researchers suggest that drivers of the spreads include changes in fiscal default probability and compensation for inflation risk – conclusions that Fed staff consider unlikely given the lack of transactions in the market. The Liberty Street Economics post is here. (Liberty Street, APS)
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