GRAPHIC-Inverted CDS, bond curves signal Ukraine default fears
LONDON, Sept 25
LONDON, Sept 25 (Reuters) - Investors are pricing a potential shock default in Ukraine over the coming year, their fears reflected in a jump in short-dated bond yields and the cost of buying one-year debt insurance in the credit default swaps market.
In normal circumstances, it is costlier to buy longer-term credit protection and yields on longer-dated debt are usually higher than on bonds maturing in the near future.
So the current curve inversion - considered a classic sign of credit stress - reflects investors' belief that Ukraine is more likely to default in the coming year than over the next five years, the following graphic shows:
One-year CDS for Ukraine, used to hedge against default or restructuring, are quoted by Markit at around 1164 basis points - an annual cost of $116,400 to insure $10 million of Ukrainian debt and a big premium to five-year CDS at 1030 bps.
"Default risk has definitely increased, which always inverts the curve. Some people clearly think default will happen sooner rather than later," said Barbara Nestor, a strategist at Commerzbank in London.
A similar inversion is evident in the cash bond market too, this graphic shows:
Nestor links the inversion with Moody's decision last Friday to cut Ukraine's rating to Caa1, seven notches into junk. With over $10 billion in debt payments by the end of 2014 and fraught relations with Russia, Ukraine may struggle to refinance.
"The fact they have now a highly speculative C-rating will cut them off from the market," Nestor added.
Ukraine's $1.5 billion bond maturing 2020 is yielding 10.7 percent, up around 100 bps since Friday, Thomson Reuters data shows. Yield on a $1 billion bond maturing next June has rocketed over 400 bps to 13.4 percent.
Ukraine's CDS are not highly liquid in the one-year segment but Gavan Nolan, head of credit research at data provider Markit, said the inversion trend has been clear since Friday.
"The fact that a similar thing is happening in the cash bond market shows the CDS curve is reflective of extreme credit stress," he said.
A Fitch ratings analyst said on Wednesday that a rapid decline in Ukraine's foreign currency reserves without a clear strategy for refinancing its debt would be negative for the country's rating.
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