It's a Tilting world in the sovereign CDS market:
We all know that the convergence between Western high-grade sovereigns and low external debt emerging market nations has gathered pace in recent years. And here's the latest development: Mexico has traded through France. Five-year Mexican CDS closed on Monday at 117bp versus France at 123bp. As of pixel time, the relationship reversed; Mexico is at 116bps while France is at 114.5bps, according to Markit.
But the broader convergence point remains. And the continued divergence between sovereign ratings and price performance for EM fixed-income assets is laid bare by the fact Mexico is a BBB-rated credit while France is -- for now -- AAA-rated. And to-date, no rating agencies have explicitly warned that France could be put on negative watch.
Mexico's macro-economic framework is seen by and large as sound -- and the country has been rewarded in kind with a $72bn flexible credit line courtesy of the IMF. But its debt profile is not perfect. Non-oil tax revenues contribute proportionately little to the government's budget. Mercifully, however, gross general government debt was only 26.8 per cent of GDP compared with 81.4 per cent in France, as of end-2010, according to IMF forecasts.
CDS markets then are pricing in economic policy flexibility in Mexico compared with the Eurozone fiscal funk combined with relatively stronger debt fundamentals in Latin America's second-largest economy. As one London-based veteran EM debt analyst puts it:
Markets are telling us a number of things, one of which is that they don’t like inflexibility [in the eurozone] – whether because a given country is tied to a monetary zone characterized by inertia, has high indebtedness, relatively poor demographics, internal bureaucratic sluggishness, etc. [by contrast] Even if investors accept that Bank of Mexico Governor Agustín Carstens is one of the hardest money guys around (core inflation being 3.2%), they welcome his flexibility to reflate if necessary, but also appreciate his no nonsense attitude while a ministry of finance official.
One final thought: from publicly available Depository Trust & Clearing Corporation (DTCC) data, you can see that the net notional amount outstanding -- i.e. the the par amount of credit protection bought or sold -- on the respective CDS contracts have also changed markedly:
Debate rages over whether a sudden up-tick in the notional amount in a given credit protection contract highlights an increase in risk aversion, or whether the relationship is more correlational in nature. But it's a trend worth following.
Plenty of fixed-income trades to mull over then, if and when the eurozone debt crisis deepens.