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Janet's Grapple

25 August 2017 by pdonnat

“Credit default swaps for the large banks also suggest that market participants assign a low probability to the distress of a large U.S. banking firm”, Janet Yellen keynote speech at Jackson Hole. The Chair of the FED dedicated most of her remarks today to the strength of the US financial institutions. The attached Grapple plots the market implied 5Y probabilities of default for the US global systemically important banks (G-SIBs). Notwithstanding the survivor bias, the Grapple shows an obvious recovery from a range of 10% - 20% cumulative implied probabilities of default at the peak of the crisis to a 3% - 6% range. The probabilities are much lower but also much closer one to another. However, they are not back to their pre-GFC tights, around 1% to 2%. The market is pricing the bail-in risk. This is matching the FED expectations. Nevertheless, a 4% 5Y cumulative default probability for JP or 6% for GS are low but far from being insignificant. Also – and this should be the subject of more studies – the machine is computing that the cluster of banks is closer to the cluster of HY credits than to the cluster of IG credits. No doubt, the banks are at risk in any reversal of the credit cycle, first affecting the HY credits. Consequently, more decorrelation of the banks’ spreads from the US HY spreads would be a strong signal on the strength of the US G-SIBs. We shall keep an eye on this Grapple.