Sovereign Credit Commentary

European credit markets experienced yet another difficult week, with ongoing concerns about the eurozone's periphery continuing to weigh on spreads.

Last week there seemed to be a consensus among the commentariat that BP PLC’s five-year spreads were overshooting significantly. A level of 500bp was outlandish for a AA credit.

After what seems like an interminable time, the credit markets switched their focus away from sovereigns and towards corporates this week. But it was the ongoing disaster in the Gulf of Mexico rather than a rediscovery of fundamentals that captured the attentions of credit traders.

The sovereign credit default swaps market exhibited the now ubiquitous volatility this week, with the Markit SovX Western Europe index reaching a wide level of 152bp on May 25. But the news flow surrounding eurozone sovereigns was unusually light, and spread direction was instead determined largely by fresh geopolitical turmoil, the plummeting euro and the fragile European banking system.

Hopes that the EUR750 billion bailout announced on May 7 would alleviate the pain of the eurozone were quashed this week as uncertainty returned to the sovereign CDS market.

After a period of unprecedented credit deterioration, sovereign credit default swap spreads rebounded sharply this week as investors digested the impact of a dramatic intervention.

Chatter about a potential restructuring of Greek debt in recent weeks had sent markets into a tizzy, but many traders still believe the E.U. will do whatever it takes to avoid a triggering of credit default swaps referencing the nation’s debt. That’s why the CDS are still trading on a running basis, rather than upfront.

It was another week of extreme volatility in the sovereign credit market as investors wrestled with escalating uncertainty.

"A default is not an issue for Greece,” European Central Bank President Jean-Claude Trichet declared this afternoon. But the activity in the credit default swap and government bond markets that morning suggested otherwise.

Norway, Finland, Sweden and Denmark occupy four of the top five spots in a CMA DataVision report ranking sovereign risk as judged by credit default swap spreads.

Ireland has been held up as an example of a country ready to suffer pain in tackling its acute fiscal situation. Credit default swaps on the nation widened by 13 basis points over the week to 141bp today—their widest level since the beginning of March—after the government announced details of the new National Asset Management Agency.

The sovereign credit default swap market has been range bound over the last week, a dearth of market-moving events causing a kind of inertia. The Markit SovX Western Europe index, a benchmark for European sovereign credit risk, closed at 68bp on Wednesday, just 2bp wider than the previous week.