Speculative players have driven up the price of Spanish long-dated credit-default swap protection by snapping up illiquid CDS on sovereign debt. Players now face a liquidity crunch as they jostle to unwind short positions in a market where sovereigns such as Spain are not heavily traded. "They are tripping over themselves," said Meyrick Chapman, strategist at UBS in London.
A number of accounts have bought EUR50-100 million in protection over the past two weeks on the back of fears an expected European Central Bank rate rise at the beginning of August will spell trouble for Spain's economy. "There are risks with Spain because it is heavily dependent on its housing market and is the most sensitive in the region to rate rises," said another London-based strategist.
Since June, Spanish 10-year CDS levels have widened to as much as 7.75 basis points from around 5.5 bps, which is a significant move for a sovereign, traders said. In addition, there has been a 6.5 bps deviation between the CDS and spreads on the underlying bonds, which have remained unchanged. Another trader noted Spanish CDS one year ago was on par with benchmark German CDS, but now there is 3.5 bps difference.
Traders across the Street expressed surprise Spanish bonds have not moved in line with CDS, but UBS's Chapman predicted this will change. "We expect Spanish bonds to under perform Germany in a similar way to the CDS, but would not be surprised to see some near-term mean reversion in Spanish CDS levels."
