In a significant development, fears over the Federal Reserve’s aggressive moves to tame inflation might tip the economy into recession have pushed up costs to insure bonds of Goldman Sachs, Morgan Stanley and Citigroup, which have hit a two-year high.
Following the war in Ukraine, credit risks have shot up since some big U.S. banks were forced to take a hit on their mainstay businesses so as to comply with US sanctions. Activity in the capital market has come to a standstill with lending expected to remain lackluster.
This has prompted bondholders to consider hedging strategies to protect against potential defaults of big US banks.
JP Morgan Chase & Co, Goldman Sachs and Citigroup have put aside a combined $3.36 billion in credit loss reserves in the first quarter, marking a reversal from the past 12 months when lenders released billions in reserves after losses related to COVID-19 failed to materialize.
Spreads on five-year credit default swaps on JP Morgan, Wells Fargo and Bank of America Corp look their two-year highs, which was seen in March.
“Any short-term spike in CDS on U.S. banks is likely related to fears over a Russian default,” said Thomas J. Hayes, chairman at Great Hill Capital in New York.
On Wednesday, a derivatives panel ruled that Russia could be in default after it failed to make a payment due on April 4 in U.S. dollars on two sovereign bonds, bringing a payout on billions of dollars in default insurance a step closer.