Japan CDS at mid-year
Japan’s sovereign CDS has tightened by about 34% from 142 bps at the in December 2011 to 94 bps in June according to the WSJ
but market participants say the tightening spreads suggest that the often-cited gauge for the country’s creditworthiness is itself broken……..
That comes despite the country’s dismal fiscal picture: Borrowing accounts for about half of all funding for the primary government budget, and the public debt is already the largest among industrial nations at roughly twice annual economic output.
“Market sentiment is dictating trading levels much more than the underlying fundamentals. I think it’s hard to grasp what these figures (price levels) mean,” said a CDS trader at a major U.S. bank in Tokyo.
Despite their relatively minor place in global financial markets, CDS prices often have an outsized influence on risk perception among broader audiences. A lack of a diverse participant base and relatively low trading volumes are further shortcomings for using Japan sovereign CDS as an indicator of the nation’s fiscal outlook.
Data from the Depository Trust & Clearing Corporation show the gross notional value of 8,149 Japan sovereign CDS outstanding contracts amounts to $85.1 billion as of June 22. That compares with total outstanding Japanese government debt at Y919 trillion ($11.5 trillion).
One factor pushing down premiums has been a broader market trend of greater willingness to hold risk. This comes amid perceptions that the chance of a widespread banking crisis in the euro zone has diminished, helping Japan sovereign CDS levels to tighten, according to analysts and traders.
Further selling came in recent weeks from large London institutional investors, Asian sovereign wealth funds, and major U.S. funds, Tokyo CDS traders at non-Japanese banks said…….
Another reason for the pricing disconnect is that Japan sovereign CDS are seldom used for their ostensible purpose–as protection for institutional investors against a default.
Japan’s debt is almost entirely denominated in yen, which Japanese authorities can create at will, even at the risk of future inflation. This is in sharp contrast to the euro-zone debt crisis where no single nation can decide to monetize its debt.
Traders also say that in order to avoid Japan sovereign risk, it is simpler and less expensive for current debt holders to begin to sell their positions than to pay the cost for the insurance.
Many in the Japan sovereign CDS market are therefore speculators who attempt to profit from price action within a relatively short term period over a few months.
Japanese corporates, meanwhile are also lower, albeit slightly, from above 180 bps at the beginning of the year to its current level around 172 bps as measured by the Markit iTraxx Japan Series 17.