Chocolate coins are now deemed safer than gilt

From the FT

Published: April 22 2009 18:00

As Alistair Darling produced his Budget goodies on Wednesday, he would have done well to peek at something which might be dubbed the "chocolate" metric.
This refers to a corner of finance known as the credit default swap - the derivatives market where investors buy protection against a debt default. In recent months the cost of insuring against a default on UK gilts has surged as investors have fretted about the ever-spiralling levels of British debt.
On Wednesday, for example, the cost of protecting five-year gilts was 95 basis points - meaning it costs £95,000 a year to insure £10m of bonds - up from 18 basis points last summer (albeit down from a peak earlier this year).
But if that is embarrassing enough, the cost of insuring the chocolate giant Cadbury was on Wednesday far lower, around 50bp. A company that peddles chocolate coins, in other words, is currently deemed a better credit bet than the British Treasury itself.
So, for that matter, are tobacco giant British American Tobacco, services provider Compass, consumer goods group Unilever, energy group Centrica and Pearson, owner of the Financial Times.
It is a startling pattern, not least because last summer all of those companies had CDS spreads which were notably higher than the UK government's. Indeed, until last year it was widely assumed that sovereign bonds would always command lower CDS spreads than corporate debt.
Will the Budget turn that chocolate metric on its head once more?


Mr Darling certainly did his best to reassure investors that gilt-edged money remained a good investment bet, declaring that the government could halve the budget deficit in four years time. He also promised that the economy would start to rebound later this year and post stunning growth in two years.
But the problem that dogs the chancellor is that few investors appear to believe in this sunny scenario. Take a look at a poll conducted at a large Investor Relations Society conference in London on Tuesday. Back in March 2008, when a similar poll was conducted, most asset managers and investor relations experts expected the financial crisis to be relatively short lived. But when the same participants were polled this week a mere 6 per cent thought the UK downturn had bottomed, while a third were braced for years of recession. Moreover, 54 per cent expected to see more UK bank bail-outs in the coming months.
Of course, those forecasts may turn out to be wrong, proving Mr Darling right. But the current problem is one of perception. After last year's shocking financial dramas, most ordinary investors are now so utterly befuddled that they have little idea what a number like £60bn, £200bn or even £2,000bn actually means.
However, as long as investors keep fearing in a general way that UK debt levels - and bail-out packages - are set to grow, amid weak or no economic growth, they will remain nervous about the credibility of gilts.
Thus far, thankfully, this unease has not produced a funding crisis for the UK government. For while mainstream asset managers feel nervous about gilts, they feel equally worried about the obvious alternatives. The price of gold is high, US Treasuries no longer look like a safe haven, and nor do eurozone bonds.
Thus, while some recent gilt auctions have produced disappointing results, the British government is still managing to sell its bonds, notwithstanding the CDS swings.
Nevertheless, in the coming months investors and policymakers would do well to keep watching that putative chocolate index. If the CDS spread on UK debt starts to fall, to a level similar to that of large British corporations such as Cadbury, then Mr Darling's Budget can indeed be deemed a success. And on Wednesday, at least, the CDS spread on gilts barely moved after his speech, implying that the markets were not unduly surprised.
But if the CDS spread on gilts remains well above those commanded by large UK companies - or if the credibility gap widens even further - it will soon be time for gilt investors to put on their tin hats. And perhaps stock up on those chocolate coins as financial comfort food.