Sovereign Credit Commentary

The credit markets were all about light flows and capitulation at the start of the week. Labor Day in the U.S. ensured that volumes were below normal, and that no doubt had a bearing on the size of the swings observed.

It was a relatively quiet week in the sovereign world as investors were firmly focused on key economic data releases and the prospect of further quantitative easing.

The Markit iTraxx SovX Western Europe closed on Thursday at a record wide of 310 basis points, proof, if any was needed, that the E.U. has failed to address the root causes of the sovereign debt crisis.

It was not supposed to be much of an event. Press coverage in the days ahead of the meeting between German Chancellor Angela Merkel and French President Nicolas Sarkozy indicated that there was little to no chance of a Eurobond issue or expansion of EFSF capabilities.

The proverbial elephant in the room this week has to be the downgrade of the U.S. sovereign rating from ‘AAA’ to ‘AA+’ by Standard & Poor’s.

The debacle over the U.S. debt ceiling was soon forgotten by the credit markets but its temporary resolution didn’t trigger a relief rally.

The euphoria engendered by the latest E.U. plan for the debt crisis had well and truly faded by last Monday. Optimism was replaced by scepticism as it became clear that the necessary detail was lacking.

The build-up to July 21 was almost palpable in the sovereign credit default swap market. The E.U. summit scheduled for that day was of crucial importance; contagion was threatening to envelope eurozone countries that are too big to bailout.

The rating agencies had a major impact on the markets last week when Portugal was downgraded to junk by Moody’s Investors Service.

We have become accustomed to Greece dominating the financial markets but this week was quite exceptional even by recent standards.

The summer of 2010 was a volatile one for sovereign credit but this year’s season looks like it could surpass it.

The state of the sovereign credit default swaps market last week could only be described as one of capitulation.