Investors turn bears on Germany and France

A bear sculpture symbolising falling markets stands in front of the stock exchange in Frankfurt, Germany, on September 12.

Story highlights

  • Investors are taking increasingly bearish bets via credit default swaps on Germany and France
  • Suggests belief EU's crisis could spread to the monetary union's stronger members
Investors are taking increasingly bearish bets on Germany and France, suggesting they believe Europe's crisis could spread to the monetary union's stronger members.
The cost of protecting German government bonds against default surged to a fresh record this week. Credit default swaps reached almost 122 basis points on Tuesday, meaning it would cost the equivalent of $122,000 annually to insure $10m worth of German paper for five years.
Buying CDS protection on Germany can equate to betting that it will have to pick up the tab for bailing out Europe's so-called peripheral nations, analysts say.
The question of how much support Germany is willing to provide to weaker eurozone members has been a point of contention between European politicians, with fierce debate over the scale and method of bail-outs taking place.
This week's reports on moves to recapitalise Europe's ailing banks appear to have added pressure to European government credits.
Investors believe banks in weaker eurozone members may receive billions of euros through Europe's collective bail-out fund, the €440bn European financial stability facility. Banks in stronger countries could be handed extra money by their own governments.
Credit Suisse strategist William Porter says investors should buy CDS protection on Germany and other European sovereigns with top credit ratings, to profit from their declining creditworthiness.
He notes that correlation -- or the degree to which European government bonds are moving together -- has increased since the start of the region's debt crisis. He suggests that the fortunes of the AAA-rated countries of Europe have recently been moving more and more in step with those of Italy and Spain.
"We have arrived at a stage of the crisis that is purely systemic," Mr Porter says.
Still, there appears to be some variation in the perceived creditworthiness of stronger European governments.
The spread between yields on 10-year French and German government bonds reached almost 75bp this week, meaning investors are demanding a higher premium to hold paper from France. The difference between the two sovereign debts hovered around 30bp until this summer.
German government bonds are still perceived as a "go to" haven for nervous investors. That means that, even as the cost of protecting German debt reached a record this week, the yield on the bonds remained stubbornly low, having fallen to around 2 per cent since the start of last month.
However, some commentators think that might change as Europe's crisis progresses.
Monument Securities' chief economist Stephen Lewis says: "As we look at the way the debt crisis is evolving, core countries will no longer be seen as safe havens, because they will be sharing some of the problems of the poorer members."