Russia Over Turkey CDS: What Is It Telling Us?
My colleagues and I have long viewed the spread of the Russian 5-year credit default swap (CDS) over its Turkish counterpart as a useful broad-based indicator for investor risk perceptions in Central and Eastern Europe (CEE). While Russia’s relatively weaker macroeconomic profile has meant that its sovereign CDS has underperformed amid spikes in investor risk aversion (such as in Q4 2008 when it traded outside Turkey for the first time), its investment grade rating (Turkey is below investment-grade) has also meant that it has outperformed as risk perceptions normalise during periods of financial market stabilisation.
Russia 5-year credit default swap over Turkey 5-year credit default swap, spread (bps)
After narrowing back to 0 in mid-May, the spread has since steadily widened back out of Russia’s favour, most recently pushing through two key support levels at 90 and 100bps, respectively. This is a key technical break suggesting that the spread could widen much further and is likely to remain above 100bps going forward. I believe this is important for two reasons. First, on a medium-term basis, it indicates that a re-inversion of the spread is off the cards. This is significant because it suggests that a normalisation of the CDS market, relative to the sovereign ratings of the two countries, is not likely. In turn, this reinforces my view that the market bounce seen since early March has been based in a technical correction as opposed to a fundamental recovery.
Second, with regards the short term, the move in favour of Turkey suggests that risk aversion will continue to rise, which bodes poorly for emerging market foreign exchange and equities. This is especially the case for the less fundamentally stable markets within CEE such as Russia. While we have seen a bounce in Russian equities and the rouble on July 14, that the Russia over Turkey CDS spread has remained below trendline support at 100bps, is a bearish signal.