Bets major sovereigns will default jump

By John Parry - Analysis

NEW YORK (Reuters) - Bets the safest countries, even the United States, may default on their bonds have soared in recent days as governments issue unprecedented amounts of debt to avert long and deep recessions.

In the United States and Europe, the cost of insuring government bonds against default have risen to record levels as countries roll out yet more massive programs to buy up battered housing-related assets and underpin tottering financial institutions.

All these rescues require huge increases in debt issuance over the next year or two. At some point, bond analysts fear, supply will overwhelm demand, degrading the perceived quality of these sovereign bonds and causing investors to demand much higher yields in the return for the risk of holding even AAA-rated government debt.

"We are talking in terms of trillions now (fiscal packages) ... and this certainly gives the impression there is a risk of a technical default," said Kornelius Purps, fixed income strategist at UniCredit in Brussels.

"However, I still can't imagine a sovereign state is going to default on its local currency debt," Purps added.

These bets, expressed via the cost of insuring such bonds against default, are nowhere near the distressed extremes of emerging markets forced to repay hefty amounts of debt in foreign currency as their own weaken.

While the cost to insure United States government debt against default over a 10-year span is now a record $55,000 a year for $10 million of U.S. Treasuries or 55 basis points, that's a fraction of the 4,000 basis points level for an emerging market country such as Argentina where some investors fear a default could happen as early as next year.

Yet credit default swaps or CDS already reflect bond investors' creeping concern that major sovereign bonds' credit quality, though still classed as "AAA", is inexorably slipping amid the biggest financial crisis since the Great Depression.

"I don't think the federal government will ever default on marketable debt outstanding. I don't think these CDS are reflecting reality," said William Sullivan, chief economist at JVB Financial Group in Boca Raton, Florida.

"The real question is what rate does our federal government have to pay to raise cash for all these programs. I don't see credit risk, I see market risk," Sullivan said.

The dollar's leading global reserve currency status builds in a certain level of foreign demand for dollar-denominated debt and although not an absolute guarantee against a U.S. default, makes that scenario fairly unlikely, analysts say.

The U.S. 30-year bond yield, at 3.5 percent and near the lowest in 50 years and Treasury bills, whose rates are close to zero, reflect scared investors stampeding into the apparent safe haven of the world's most liquid government bond market.

Even so, U.S. government debt could be drubbed once investors sense the bubble in the Treasury market is bursting, sending borrowing costs skyrocketing and dealing more blows to an already battered economy, said Jes Black, fund manager at NetBlack Capital in New York.

Because the U.S. government has hugely inflated the supply of money, by at least $4 trillion in the space of a few months, to rescue the financial system, the risks of a sudden, savage selloff in U.S. Treasuries are high, Black says.

While CDS protection costs for U.S. Treasuries rose to a record this week after the United States government announced fresh steps to buy consumer loans and related securities in a bid to avert a deep recession, in Britain CDS rose to a record 104 basis points for 10-year debt.