Much in the way that monetary stimulus has turbocharged equities, unprecedented low
interest rates in developed and emerging markets have artificially compressed credit default
swap spreads. As the charts below show, CDS spreads are anchored at the bottom end of
the post-2013 trading range (for which we have comparative data), despite the continued
increase in government debt since the financial crisis.

This has emboldened many governments to issue more longer-term and local currency debt.
However, the tide is now turning as emergency monetary policy measures are gradually
being unwound. This risks exposing those markets where governments have not got the
fiscal house in order. In this regard, Japan deserves special mention. Despite the largest
outstanding government debt relative to GDP (235%), the 5-year CDS trades at 35bps
indicating negligible default risk – a significant disconnect which will revert one way or
another over the longer term.

(Click on image to enlarge.)

Source: Bloomberg, Macrobond and Variant Perception