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The Sovereign Risk Dislocation Trade Means Big, Black Clouds Coming To "Risk Free"

• www.zerohedge.com

As early as July, we pointed out the increasingly likely endgame in Europe with regard to the EFSF and centralizing/concentrating credit risk. Well sure enough, sovereign risk has risen dramatically for Germany (among many others obviously) as traders realized standing on the shoulders of giants does nothing but push them further into the dirt. What is becoming more worrisome, and dramatically escalating, is the rise in sovereign CDS relative to government bond yields - or the so-called 'basis' - as it becomes ever more clear that government-bond-yield-by-mandate may not be as 'real' a measure of the risk-free rate as CDS.

Sovereign CDS are denominated in non-local currency - i.e. the spread not only accounts for the chance of technical default but also of a hyperinflationary revaluation of the currency. It is this fact that could make them a far more accurate indication of the real risk in government bond markets - far more so than government bond yields themselves as they remain largely under government or central bank mandate wherever we look.

Charts: Bloomberg

This week saw German CDS pass Bund yields for the first time ever in the 5Y maturity. The 1 week change was over 3 standard deviations - the largest ever! Also notice the Swiss basis jumped when they announced their EUR-peg / implict devaluation 'effort' and how it has pulled back more in line with Germany in the last week or so.

 

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