Germany Credit Risk Lowest in Two Years as Euro Optimism Builds

German debt risk fell to the lowest in two years as the prospect of the nation picking up the bill for bailing out indebted nations diminishes now the European Central Bank pledges to use its balance sheet to ease turmoil.

Credit-default swaps insuring German bunds for five years fell to 35 basis points at 11 a.m. in London, the lowest since October 2010 and down from a record 125 basis points a year ago. The contracts cover a net $18 billion of German debt, the lowest in 13 months and down from a record $22.4 billion Aug. 3.

Investors are growing more confident European leaders meeting in Brussels today will ensure Greece remains a member of the euro area and that central bank pledges to buy bonds of Spain and Italy will ease the debt crisis. German Chancellor Angela Merkel proposed a “solidarity” fund to bolster competitiveness in struggling countries, saying stability is taking hold after three years of turmoil in the euro area.

“The risk of contingent liability for Germany is becoming less,” said Alessandro Giansanti, a strategist at ING Groep NV in Amsterdam. “Spain can issue bonds and there will be ECB support, and for Italy the cost of financing is coming down.”

Spain’s bonds rose for a third day as the nation raised more than planned at a debt sale. The country sold a combined 4.61 billion euros ($6.1 billion) of due in 2015, 2016 and 2022, the Bank of Spain said, compared with a maximum target of 4.5 billion euros.

Most Traded

Credit-default swaps on Germany were the most traded and had the biggest increase in volumes among 1,000 entities tracked by the Depository Trust & Clearing Corp. last week as traders pared risk bets. Investors traded 180 contracts covering a gross daily average of $1.42 billion in the week through Oct. 12, compared with an average of $1 billion the week before and over the previous month.

“German CDS is often used as a European tail risk hedge,” said Michael Hampden-Turner, a strategist at Citigroup Inc. in London. “People are taking them off as urgency of European structural change is perceived to have diminished.”

Germany has the third most debt protected by credit-default swaps after France and Italy. Contracts on France now cover a net $20.7 billion, down from a record $25.7 billion in August 2011, while Italian swaps protect $20.7 billion compared with a record $29.5 billion in November 2010.

The market for sovereign credit derivatives is drying up ahead of regulation from the European Commission that will ban so-called naked swaps that are used to speculate rather than insure underlying bonds.

Trading of the Markit iTraxx SovX Western Europe Index of credit-default swaps on 14 governments has evaporated, with fewer than 10 trades outstanding on the series that started last month. There were 15 trades covering $40.2 million of the previous series last week and eight trades on two other versions of the benchmark.

Swaps pay the buyer face value in exchange for the underlying securities or the cash equivalent should a borrower fail to adhere to its debt agreements.

To contact the reporter on this story: Abigail Moses in London at Amoses5@bloomberg.net

To contact the editor responsible for this story: Paul Armstrong at Parmstrong10@bloomberg.net

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