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TheStreet Open House

Global Macro: Equity and Credit Protection Slightly Split

NEW YORK ( TheStreet) -- Markets for protection in both equities and credit are telling slightly different stories about the debt-ceiling debate, but both predict an actual default is unlikely.

Equity markets are not seeing robust demand for downside protection, even though failure to negotiate raising the debt ceiling would lead to a steep selloff in equities.

Credit protection, known as credit-default swaps, on the other hand, are at highs not seen since August 2011.

In times of fear, equity investors buy put options as a form of downside protection on their assets in case prices drop rapidly.

In credit markets, investors protect their assets from potential default risk by purchasing CDSs to hedge returns on principal if a default does occur.

Prices on Treasury CDS over the past week have jumped from 5 basis points to nearly 40bps. That looks like a large percentage jump, and it is considering prices haven't been this expensive since the last debt-ceiling fracas occurred, when Standard and Poor's downgraded U.S. government debt.

Although CDS prices have spiked, prices remain low relative to other countries with higher default probabilities such as Portugal or Greece.

That essentially means that investors are bidding up the price of U.S. CDSs, but not to levels that an actual default is expected.

A confirmation that fears about the debt ceiling have not gotten out of hand, the iPath S&P 500 VIX ST Futures ETN (VXX) remains at yearly lows, as seen in the chart below.

Equity market volatility is usually expected as the days move closer to a government shutdown.

Now, however, we expect political wrangling and a last-second resolution to the problem.

The U.S. government is as polarized as it has ever been in recent decades, leading to even the simplest policy debates splitting factions down the middle.

The same warning song has been sung too many times in the case of U.S. debt default, and markets are pricing in business as usual until it isn't.

At the time of publication the author had no position in any of the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

Andrew Sachais' focus is on analyzing markets with global macro-based strategies. Sachais is a chief investment strategist and portfolio manager at the start-up fund, Satch Kapital Investments. The fund uses ETF's traded on the U.S. stock market to gain exposure to both domestic and foreign assets. His strategy takes into consideration global equity, commodity, currency and debt markets. Sachais is a graduate of Georgetown University, where he earned a degree in Economics.

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