Friday, May 27, 2011

US to default?

With the world and their Mother watching the European sovereign debt drama unfold with abated breath, the not insignificant risk posed by a U.S. sovereign debt crisis increases by the day. The risk of a US default continues to rise which can be seen in the sharply increased cost to insure U.S. sovereign debt. Risk of a U.S. default can be seen in the credit default swap (CDS) market. 1 year U.S. CDS has risen from 23 to 37 or by 60% in the last six trading days (see chart).

The orange line is the US CDS premia, yellow is Japan and pink is the UK.

In the more liquid 5 year U.S. CDS, the cost to insure has risen by some 50% in the last week. Whereas there is normally minimal trade in the US CDS market, the norm is a handful of trades (sometimes as low as one), last week saw investors placing 135 trades in U.S. CDS’s. Just to compare, there were 360 CDS trades on Spain's sovereign debt, 191 on Greece, 142 on Portugal and 136 on Italy. A US default would not be “catastrophic” it would likely lead to a very sharp fall in the U.S. dollar, (especially versus the hard currency, collateral and monetary asset that is gold), sharp fall in U.S. bonds and sharply higher interest rates. This has the potential to create another systemic crisis involving sovereign nations and banks globally and could lead to a deep recession. Indeed, it would not be unfathomable to suggest that the S&P “warning” of US debt was a mere warning precisely because it was the US in question. Anyone else would have resulted in a downgrade of 3 notches at least!-----------------------------------------------------------------------------------------------------------------
LEGAL DISCLAIMER: The views mentioned above are purely that of the author, and does not necessarily reflect the official view of Goldrock Capital or employees. Unless of course the aforementioned view was a phenomenally good call, with exquisite market timing, in which case Goldrock Capital reserves the right to all credit!!!!!

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