The neo-medieval trade

Posted by Joseph Cotterill on Nov 01 16:53.
Markit pointed out something interesting on Monday: there’s a record spread between their iTraxx Europe and SovX Western Europe CDS indices.
Chart via Bloomberg, click to enlarge:

SovX WE — which is filled with such wholesome sovereign goodness as Portugal and Ireland — has obviously had a few down days recently, on account of renewed troubles within its weakest members.
Not to mention possible EU treaty changes on deficit control that might favour sovereign debt restructuring in the long run. ECB board member Lorenzo Bini Smaghi seemed less than cheerful on the changes’ ability to force fiscal reform in a speech made on Monday, so there’s one to watch.
But how about the performance of the 150 investment-grade corporate credits housed inside iTraxx Europe, eh?
This does bring to mind a recent historical meditation by Citigroup’s chief economist Willem Buiter (emphasis ours):

Historically, before the 19th century, the norm everywhere (including in the countries that we now characterize as advanced economies) was that sovereign risk tended to be worse than the credit risk of leading merchants or private bankers…
The poor credit rating and performance of sovereigns in Western Europe before the 19th century should not come as a surprise, as prior to the modern age of broad-based income taxes and indirect taxes, the sovereign’s revenue sources were limited…
We would not be surprised, for instance, to see leading Spanish banks trading through the Spanish sovereign and we have already observed instances in which Italian or Greek companies had CDS spreads that were below those of the sovereign…

Although we’re probably just being dramatic.
Then again, Barclays Capital analysts had the clever idea last month of selecting European corporate credits demonstrating the lowest possible correlation to the SovX, in a bid to avoid volatility.
Click BarCap’s charts to enlarge:


BarCap don’t like financials, however, given their high correlation to their sovereigns. Bad news for the iTraxx Europe Senior Financials.
Beyond that — perhaps this is a trade going back to the future.

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