Today’s U.S. employment report will be a major focus of market narratives as investors attempt to plot the course of the Federal Market Open Committee taper, in other primary developed markets, stimulus remains the order of the day. Yesterday’s European Central Bank rate cut announcement could result in nearly €700 billion ($907 billion) in fresh liquidity for the EU’s sluggish economy, while fresh saber rattling by the administration of Japanese Prime Minister Shinzo Abe suggests more government market intervention is on the way. As the trading week draws to a close, market risk narratives remain firmly affixed to these diverging policy regimes rather than fundamental or geopolitical factors.
Nebraska’s top court considers pipeline. The fate of the $5.4 billion Keystone XL pipeline project will be partially in the hands of the Nebraska Supreme Court in sessions beginning today. Governor David Heineman has asked the court to rule on an earlier trial verdict which negated legislation that allowed the pipeline, owned by TransCanada Corp., to cross the state.
U.S. employment to be released today. The U.S. Department of Labor is issuing its August employment situation report. Economists’ consensus forecasts predict a meaningful advance in the nonfarm payroll count, a marginal increase in average hourly earnings and a drop in the headline unemployment rate to 6.1 percent from 6.2. With FOMC policy as a primary catalyst for global market sentiment, this release will be critical for investor risk positioning across all traded asset classes.
Germany shows production increases. Industrial output data for July released by Germany’s Ministry for Economic Affairs saw the largest increase in more than a year at 4.6 percent year-over-year or 1.9 percent versus June’s level. This strong showing, which beat forecasts, was driven by a large uptick in foreign demand. This positive data point, while somewhat stale, helps partially offset increasing concerns that the momentum of the broader German economy is losing steam.
Railway merger discussed in China. Rumors that China’s two largest train manufacturing firms, CSR and China CNR, have been capturing headlines yesterday and today, as independent media channels speculated that the coupling would be prompted by the State-owned Assets Supervision and Administration Commission (SASAC). Both companies initially denied knowledge of any such negotiations. As Chinese infrastructure improvements continue to be a focus of government investment, the combined company would have a significant advantage in economies of scale according to many analysts; however the merger would significantly impact competition in the high-speed train segment.
Japanese minister sizes up Abenomics. In an interview with reporters today, Akira Amari, Japan’s minister for national strategy and economic policy, said that the nation’s government is prepared to unleash new stimulus measures to offset a fresh increase in the sales tax scheduled for next year. The first increase implemented earlier this year has been politically controversial and has been blamed by many observers for causing the pace of economic recovery to slow down. Separately the Bank of Japan released its monthly economic report today with a tone of caution noting that industrial production is on track to remain flat in the third quarter but that a modest rebound in exports is anticipated.
Portfolio Perspective: Sovereign Credit-Default Swaps; Past, Present and Future — Soren Willemann, Barclays
Sovereign CDS for Western Europe will undergo significant changes following the implementation of the 2014 ISDA Credit Definitions, most of which benefit protection buyers. We are reviewing the changes and their valuation and accordingly, we recommend selling Italy protection.
What are the most important changes? The most important change allows for so-called Asset Package Delivery, which ensures that in a restructuring, CDS has the same economic outcome as that of bonds. A clean euro exit has also been carved out from triggering CDS with the general language about redenomination clarified. General changes to Qualifying Guarantee language also increase the scope for using sovereign CDS to hedge government-guaranteed bonds.
What is the impact on spreads? Given that most changes benefit protection buyers, 2014 CDS should trade wider than current 2003 CDS. For that reason, Western European sovereign CDS is excluded from the 2014 protocol. Two aspects complicate calculations, however. One, as sovereign restructurings are — thankfully — quite rare and have a diverse range of outcomes, it takes a leap of faith to rely on empirical observations to imply new fair trading levels. Two, the CDS-cash basis is generally positive, making it difficult to imagine that 2014 CDS will open materially wider. On a pragmatic point, we would argue that the biggest flaw in the 2003 definitions, lack of Asset Package Delivery, is not priced in current CDS levels. With this in mind, we expect 2014 CDS to open as much as 10 percent wider than 2003 CDS.
Soren Willemann is head of European credit strategy at Barclays in London.
