What Do Yields Say?

As you know, Paul, I’m skeptical about the reliability of CDS market information … especially in the sovereign markets.

So while I loved your last feature on sovereign default risk, I’m not sure I buy what the CDS market is saying. You mention at the end, almost in passing, that CDS spreads are not necessarily reflected in bond yields. You write:

“There is the possibility of divergence (basis risk) between CDS spreads and bond yield spreads. Nevertheless, CDS spreads should give a pretty accurate reflection of the real funding costs faced by Eurozone governments.”

Is that a riddle?

It seems to me like yields are the best measure of funding costs. Why choose the derivative CDS market when you can go right to the source?

I know that a few bond auctions have failed in Germany over the past few months, and that’s a legitimate concern. But in most cases and in most countries, governments can still raise all the money they want at historically low interest rates.

Isn’t the hugely liquid bond market a better measure than the troubled CDS group? And what does that say about risk in these markets today?

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