U.S. debt seen riskier than UK counterpart

NEW YORK (Reuters) - The cost to insure British government debt against the theoretical risk of default is double that of the United States, but recent moves in the prices of sovereign bonds suggest investors are more concerned about the United States' expanding borrowing requirement.

In this tale of two signals, the tried and tested harbinger

is long-established government debt markets, which more closely reflect investor sentiment about a sovereign's credit-worthiness, analysts say. Pricing in the nascent credit default swap (CDS) market is probably deceptive, analysts said.

While governments have been issuing debt for centuries, the credit default swap market for these two sovereigns started trading actively just two years ago as the global credit crisis started to unfold. These sovereign CDS are not very widely traded and so a poor guide to the chances of an actual default of Britain or the United States, seen as highly unlikely, analysts say.

Instead, the CDS hint how concerned investors are about a government's indebtedness and the possibility of an acute selloff in the sovereign debt market and of the currency: by no means a trivial concern.

On Wednesday, UK 5-year credit default swaps were at 80.5 basis points, roughly double the 38.9 basis points for the United States, according to CMA Datavision.

However, "the fiscal situation in the U.S. is much worse than the market appreciates, and the market is just starting to focus more on this issue," said Doug Noland, senior portfolio manager of the Federated Prudent Global Income Fund at Federated Investors in Pittsburgh, Pennsylvania.

The U.S. government has said it will need to borrow $2 trillion, or 14 percent of the country's total economic output, in 2009 alone, and the UK government's borrowing is near that proportion. But the additional burden in the United States from mortgage giants Fannie Mae and Freddie Mac, which the government controls, could force much bigger borrowing, says Noland.

Investors are only now starting to factor in the full weight of the long-term problems confronting the United States.

"If one assumes the price action in both reflects the same impulse, most particularly a focus on the credit-worthiness of the sovereign, the relative movements of the U.S. and UK CDS and government bonds should be consistent," said T.J. Marta, founder and market strategist with research firm Marta on the Markets in Scotch Plains, New Jersey.

"However, the relative moves have not been consistent," Marta noted.

As governments on both sides of the Atlantic have stepped up hefty debt issuance in the past two months, U.S. Treasuries have sold off more sharply.

The benchmark 10-year Treasury note's yield, which moves inversely to its price, has risen some 112 basis points since mid-March. The equivalent 10-year UK gilt yield has risen about 95 basis points in a less acute selloff.

Even Standard & Poor's decision to give a negative outlook to Britain's top AAA credit rating on May 21 jolted U.S. government bonds and the dollar more than their UK equivalents.

"All of a sudden S&P brings an important issue to the market and the market realizes this is a much more dangerous development for the U.S. than anyone else," Noland said.

"Especially over the last couple of weeks you are seeing the reemergence of dollar bears, you are seeing the pound rally back and we are starting to see U.S. Treasuries not perform well relative to global bonds," said Noland.

Pricing in the credit default swap market, currently showing bigger concerns about UK gilts, may soon shift to reflect bigger risks in the United States, he added.

Currencies, although subject to many catalysts, hint investors are more concerned about the United States.

Since mid-March, the pound has won the lesser-of-two-evils contest, gaining some 20 percent against the dollar. To some extent, the dollar has suffered as global investors have become less risk averse, selling U.S. Treasuries and shifting into riskier assets globally.

Yet some analysts fear that foreign investors will start selling dollar-denominated Treasuries or demand much higher yields because of the government's huge debt issuance.

"The markets are going to discipline Washington," Noland said. "It is clear we are in a government finance bubble right now," he said. "I am worried that we are building toward a very severe currency crisis here," he said.

(Reporting by John Parry; Editing by Kenneth Barry)