In his latest missive for the FT, PIMCO’s Mohamed El-Erian sounds the alarm on core infection:
Also interesting, and less noticed, is what is happening in a still-obscure market segment that sheds light on sovereign credit risk, albeit imperfectly. There, spreads on German credit default swap have quietly widened to around 120 basis points in the last few days.
Such previously unthinkable levels are fundamentally inconsistent with Germany’s very strong sovereign balance sheet and its impressive record of successful multi-year economic reforms. Admittedly, the situation is mainly a reflection of bank-related counterparty risk issues and imperfect portfolio hedging. Yet, at around twice the US level, the CDS spreads may also speak to market uncertainties regarding the size of the contingent liabilities that Germany could face on account of the eurozone crisis.
This idea of ‘core infection’ has been anticipated by some for a while, including CLSA’s Chris Wood, who encouraged a bet on French and German CDS back this Spring.
Beyond the fact that Germany may end up shouldering the burden of the rest of Europe, the fact of the matter is that unlike the US and Japan, Germany can’t print money at will.