Slovenia CDS gives warning signals

European sovereigns may not be the topic du jour they once were, but only the most optimistic would state that the eurozone's problems are behind it.

One need only look at Slovenia, a small and relatively recent entrant into the currency bloc but important nonetheless. The European Commission yesterday forecast that the Balkan country's GDP would contract by 2.7% this year and a further 1% in 2014, making it one of the weakest performers in an already struggling region.

Like Ireland and Spain, the banking sector lies at the heart of the country's problems. Bad debts have been mounting and the recapitalisation costs will mean that Slovenia's budget deficit next year will be 7.1%. Unlike Ireland and Spain, however, the damage was largely done by loans to state enterprises, rather than private real estate.

Slovenia's CDS spreads shot up to 400bps when the bad debt issue became more acute in March, and are still trading at 320bps, about 90bps wider than where they started the year. Compare this to Spain and Italy, which were both trading considerably wider than Slovenia in January. They are now 150bps and 120bps tighter than Slovenia respectively.

This is partly a reflection of the ECB's commitment to supporting the eurozone, which has benefited Spain and Italy's spreads disproportionately. But it is also a product of Slovenia's difficult situation, particularly the uncertainty around whether it will need a bailout. The EU expressed confidence that Slovenia's planned reforms will buy some time and enable it to fund the necessary recapitalisations. We may find out if this confidence is justified after banks stress tests results are published early next year.

In the corporate world, credit markets took a breather ahead of crucial economic events due tomorrow and Friday. The Markit iTraxx Europe has traded in a 1.5bp range for over a week, and was unchanged today at 85bps.

French engineering group Alstom was the top performer after it posted better than expected results and announced a corporate restructuring. Credit investors were pleased by plans to sell between €1bn and €2bn worth of assets. Alstom's spreads rallied 15bps to 151bps, the tightest level since May.

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