Selling five-year credit default swaps on Germany brings greater yield than buying cash bonds because the CDS spread is skewed wider on European sovereign risk, according to a report by Munich-based Assenagon Capital Management.
According to Markit, spreads on five-year German CDS were 101 basis points at press time; Bloomberg has the yield on five-year German bunds at 0.5%, or 50 bps. Should a firm get its exposure to German credit synthetically rather than through cash bonds, it would receive over 100% more in yield.
“The current CDS level can be seen in the absolute yield levels of German sovereign bonds,” the report says. “In fact, it represents a good opportunity to buy exposure to Germany.” The report goes on to say that buying German CDS would cause spreads on the instrument to narrow.
According to the report, the spreads are wider because German CDS are included in the Markit iTraxx Western European sovereign CDS index, or the iTraxx Main. The index is equally weighted, so, according to Assenagon, there is a price effect on the single-name German CDS. “German CDS will then widen even if there are no direct purchases of CDS on Germany,” the report says.
The report goes on to note that non-European investors purchase German CDS to hedge against a transfer union, or the risk of the common currency falling apart. “In a perfect transfer union there would be strong convergence in yield differences between the member countries, making it sensible to buy CDS on ‘good’ countries like Germany,” the report says. “In other words, German CDS are currently not reflecting Germany’s situation in isolation, but its role in a currency union. That is by no means illogical in economic terms; it is a question of perspective.”
The report, which was published May 15, said that the bunds yield 0.55% and German CDS spreads were 85 bps.
