G4 Countries: The Big Kahuna(s) of Sovereign Risk

In the days of the Roman Republic, the imperator of a particularly successful or important military campaign was occasionally awarded a triumph. This festive ceremony featured a parade of captured bounty and prisoners, interspersed with Roman soldiers signing bawdy songs about their commander, who would wave to the cheering crowds from the back of a chariot. And behind the chariot would walk a slave, whose sole job was to whisper in the ear of the conquering hero “Remember that thou art mortal.”

At the risk of beating a dead horse, 2009 has, in aggregate, played the role of the slave in Macro Man’s investment career. As if he needed further proof, a couple of the trades that he cut yesterday have come roaring back today. It’s a slap in the face, but not altogether unexpected, and Macro Man has to laugh (if only so he won’t cry.) In any event, those trades are done with, and there’s no utility to be gained from crying over spilt milk.

Anyhow, while Macro Man is in wind-down mode for the year, he is still keeping a watchful eye on things. One little item that has caught his notice is the relative outperformance of Korea in the aftermath of the initial Dubai flare-up. For the two months after late September, the Kospi couldn’t buy a friend, and badly underperformed the rest of global equities. Since “Dubai”, it has surged, even breaking out of its downchannel resistance. Does it mean anything? Macro Man isn’t sure…but it is interesting.

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Also of interest is the swirling talk around sovereign risk. Te Nakheel bond maturity is rapidly approaching, and while there have been some mumbles about ad hoc support from the government, there’s been nothing concrete announced. Similarly, Greece continues to get pummeled, with 5 year CDS widening out beyond 200 bps this morning.

The Big Kahuna(s) of sovereign risk, however, are G4 countries. While Japan is its own special case, the US and UK have come under renewed scrutiny, and not simply because it’s the time of year when banks roll out their “year ahead” research products. Today’s WSJ carries a story noting that Moody’s has changed its language on the US and UK, possibly opening the door to a downgrade by 2013.

While that’s still an unlikely outcome (doom-mongering to the contrary), it does highlight the risks posed by the fiscal situation in both countries. Macro Man had to laugh at a recent story that the Obama administration would use some of the TARP money to pay down the deficit. It really highlights the absurdities of US government budget accounting, because it seems to be common sense that the best way to “use” the TARP to reduce the deficit would be by…err….not using it! In any event, US CDS has started to tick higher again, though it remains well below the panicked levels of last year. Still, it’s worth keeping an eye, particularly in the context of shaky performance by the peripherals.

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In the UK, meanwhile, we get the Government’s “go for broke” mini-budget that is widely seen as a last-ditch effort to revive Labour’s sagging electoral fortunes. The other day, Macro Man wondered to himself what Mr. Darling would propose if he were actually interested in a goal other than saving his own political skin, then chuckled at the absurdity of the notion. In any event, expect some focus on windfall taxation of banking bonuses, which will no doubt raise howls of protest from the Square Mile and satisfied taunts of “Unluggy!” from the other 94,525 square miles of the United Kingdom.

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In any event, UK sovereign risk is likely to remain in focus for some time, given the forthcoming election next year and the potential for a hung Parliament. Macro Man doesn’t know how it will play out and is happy to remain on the sidelines. Trying to guess how this will play out would likely provide him with another slave-like reminder…..

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