While equities and commodities have collapsed, alongside widening corporate credit spreads, sovereign CDS have not reacted to the coronavirus crisis as might be expected. CDS spreads have widened, but current spreads pale in comparison to the 2008 financial crisis (and, for the euro area, the subsequent 2011-2012 sovereign-debt crisis). This is despite a far more precipitous economic contraction on the back of recent national lockdowns and an unprecedented fiscal response.

The ban on naked shorting of CDS in the EU (made permanent in 2011) may be a contributing factor in European markets, but that would not explain why spreads have been similarly contained in non-EU countries. The demand for safe assets and coordinated global monetary easing, which has lowered government borrowing costs and eased funding stresses, provides another possible explanation. However, CDS pricing could also reflect an expectation that much of the recent fiscal stimulus will ultimately be monetised by central banks. Indeed, CDS pricing reflects the probability of a traditional credit event occurring (failure to redeem or pay coupons, debt restructuring etc) rather than a ‘backdoor’ default aided by central banks.

Source: Bloomberg, Macrobond and Variant Perception