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Moody's Market Signals Sovereign Risk Report Summary

Core Content

This report from Moody's Capital Markets Research (CMR) provides an analysis of market-based credit risk measures for various sovereign entities, focusing on the changes in the Expected Default Frequency (EDF) over the week ending July 11, 2014. The EDF measures are derived from credit default swap (CDS) spreads and reflect forward-looking probabilities of default. The report highlights the dynamics of risk for countries like Puerto Rico and Argentina, which showed significant changes in their credit risk profiles, while others remained relatively stable.

Main Points

• Puerto Rico's Default Risk Increased:

  • Puerto Rico's Sovereign EDF rose sharply from 6.6% to 9.17%, the highest level in five years.
  • This increase is attributed to the ongoing debt crisis and legislation allowing certain agencies to restructure their debt, which raised concerns about potential wider financial turmoil.
  • Bond prices for Puerto Rico declined, with 10-year General Obligation bonds priced as low as 66, yielding over 10.96%.
  • CDS spreads for Puerto Rico widened by 200 basis points (bps), now trading at over 1,600 bps.

• Argentina's Default Risk Decreased:

  • Argentina's Sovereign EDF improved from 5.4% to 2.7%, corresponding to a B1 rating.
  • The improvement is linked to new developments in negotiations with holdout creditors, despite the country still being in a 30-day grace period after missing coupon payments.
  • The one-year EDF fell below the five-year EDF, indicating a potential resolution to the financial dispute.
  • The country's EDF dropped by 50% since the meeting between the Economy Minister and the court-appointed attorney.

• Other Countries:

  • Ukraine and Venezuela: Remained unchanged during the week.
  • China: Sovereign EDF stayed stable at 0.04%, with a slight improvement in CDS implied ratings.
  • Japan, Korea, and others: Showed minor fluctuations in their EDF and implied ratings, with some improvements in CDS and bond implied ratings.
  • Greece, Portugal, and others: Displayed a decline in EDF, suggesting reduced risk, but still had higher risk levels compared to other countries.
  • Cyprus, Ireland, and Italy: Experienced significant declines in EDF, reflecting improved market sentiment and potential financial support.

Key Information

• EDF Calculation: Sovereign EDF is a forward-looking probability of default extracted from CDS spreads, adjusted for loss-given default and the market price of risk.
• Rating Correlation: EDF measures are mapped to credit ratings using historical default rates, with lower EDF corresponding to higher credit ratings.
• Market Sentiment: Changes in EDF reflect investors' perception of credit risk and potential for financial distress.
• Negotiations Impact: The resolution of disputes between governments and creditors significantly influences EDF and market-based risk assessments.
• Regional Overview:
  • Asia-Pacific: Countries like Australia, China, and Japan showed stable or slightly improved EDF.
  • Europe: Countries such as Greece, Portugal, and Ireland experienced notable decreases in EDF, while others like Austria and Germany remained stable.
  • Russia and Serbia: Displayed minor changes, with Russia's EDF decreasing slightly.

Summary Table

Conclusion

The report underscores the dynamic nature of sovereign credit risk, as reflected by EDF measures. It illustrates how market signals can shift based on economic conditions, policy changes, and negotiations, providing valuable insights for investors and policymakers. The analysis shows that while some countries like Puerto Rico face heightened risks, others such as Argentina and several European nations show signs of improvement.