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Politics Versus Economics

There was an interesting note from Bloomberg showing that the default probability in 1 year credit default swaps on the US government spiked quickly to surpass the credit spread in 5 year credit default swaps for the first time:

This is interesting, but a few points to note.  I am seeing 5 year CDS at a 52 week high of 62.47 bps.  I am seeing 1 year CDS at a high of 80 bps.  If we assume simple assumptions of 40% recovery on both, this is implying a 1.35% chance of default in the 1 year spread and a 5.14% chance of default in the 5 year spread.  Neither of these spreads are scary, and if you assume that there is a 1% chance of default in any given year then the two are not incongruous.

In addition, we have seen little move in short term treasury yields.  In fact, 1 month treasury yields have moved from lows of -.015% on July 13, 2011 to +.077% or less than 8 bps today.  Not much fear in the 1 month numbers.  2 year treasury rates?  They have increased from 35 bps to 43 bps.

The current point is that there has been little fear in the markets so far.  This might be a media panic event, but as of today the markets view it as a non-event.  Hopefully the markets do not discount the stupidity of politicians too far.

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