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Interbank Risk continues to mount in this morning's Risk Monitor, as measured by the TED spread, the Euribor-OIS spread, and the ECB liquidity deposit. All three series made new highs in the last week. This demonstrates that risk in the system has not abated in the slightest.
* The TED spread made a new YTD high at 54.2 bps, indicating risk in the banking system continues to rise. We consider the TED spread to be a more sober reflection of systemic risk in the banking system. This is a strong cautionary note amid widespread equity gains.
*Credit default swaps for Eurozone countries widened on Monday. Italian swaps were particularly noteworthy widening by 27%.
* We have added two new series to our Risk Monitor, the Euribor-OIS spread and the ECB Eurozone Liquidity Recourse to the Deposit Facility. Both measure interbank lending risk in the Eurozone.
* Our macro quantitative model indicates that in the short term (TRADE), there is currently around 1.8 times more upside than downside in the XLF (2.2% downside vs. 3.9% upside).
Financial Risk Monitor Summary (Across 3 Durations):
- Short-term (WoW): Negative / 2 of 12 improved / 3 out of 12 worsened / 6 of 12 unchanged
- Intermediate-term (MoM): Negative / 2 of 12 improved / 5 of 12 worsened / 5 of 12 unchanged
- Long-term (150 DMA): Negative / 1 of 12 improved / 9 of 12 worsened / 2 of 12 unchanged
1. US Financials CDS Monitor – Swaps tightened for 22 of 27 major domestic financial company reference entities last week.
Tightened the most vs last week: MTG, RDN, TRV
Widened the most vs last week: AXP, MBI, AIG
Tightened the most vs last month: GS, COF, CB
Widened the most vs last month: SLM, RDN, MBI
2. European Financials CDS Monitor – Bank swaps were wider in Europe last week for 25 of the 40 reference entities. The median widening was 14.4%.
3. European Sovereign CDS – European sovereign swaps mostly widened last week. Italian sovereign swaps widened by 27% (+117 bps to 549) and Spanish by 20% (+74 bps to 434).
4. High Yield (YTM) Monitor – High Yield rates rose 1 bps last week, ending the week at 8.96 versus 8.95 the prior week.
5. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 2 points last week, ending at 1578.
6. TED Spread Monitor – The TED spread rose 1 point last week, ending the week at 54.2 this week versus last week’s print of 53.3.
7. Journal of Commerce Commodity Price Index – The JOC index rose 1 point, ending the week at -20.2 versus -21.2 the prior week.
8. Euribor-OIS spread – The Euribor-OIS spread (the difference between the euro interbank lending rate and overnight indexed swaps) measures bank counterparty risk in the Eurozone. The OIS is analogous to the effective Fed Funds rate in the United States. Banks lending at the OIS do not swap principal, so counterparty risk in the OIS is minimal. By contrast, the Euribor rate is the rate offered for unsecured interbank lending. Thus, the spread between the two isolates counterparty risk. The Euribor-OIS spread tightened by 3 bps to 96 bps versus last week’s print of 99 bps.
9. Markit MCDX Index Monitor – The Markit MCDX is a measure of municipal credit default swaps. We believe this index is a useful indicator of pressure in state and local governments. Markit publishes index values daily on six 5-year tenor baskets including 50 reference entities each. Each basket includes a diversified pool of revenue and GO bonds from a broad array of states. We track the 14-V1. Last week spreads widened, ending the week at 184 bps versus 173 bps the prior week.
10. Baltic Dry Index – The Baltic Dry Index measures international shipping rates of dry bulk cargo, mostly commodities used for industrial production. Higher demand for such goods, as manifested in higher shipping rates, indicates economic expansion. Last week the index rose 56 points, ending the week at 1922 versus 1866 the prior week.
11. 2-10 Spread – We track the 2-10 spread as an indicator of bank margin pressure. Last week the 2-10 spread widened to 183 bps, 5 bps wider than a week ago.
12. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 3.9% upside to TRADE resistance and 2.2% downside to TRADE support.
13. ECB Liquidity Recourse to the Deposit Facility – The ECB Liquidity Recourse to the Deposit Facility measures banks’ overnight deposits with the ECB. The ECB pays lower rates than the market, so an increase in this metric demonstrates increased perceived counterparty risk and liquidity hoarding.
Margin Debt in October
We publish NYSE Margin Debt every month when it’s released.
NYSE Margin debt hit its post-2007 peak in April of this year at $320.7 billion. The chart below shows the S&P 500 overlaid against NYSE margin debt going back to 1997. In this chart both the S&P 500 and margin debt have been inflation adjusted (back to 1990 dollar levels), and we’re showing margin debt levels in standard deviations relative to the mean covering the period 1. While this may sound complicated, the message is really quite simple. First, when margin debt gets to 1.5 standard deviations or greater, as it did this past April, that has historically been a signal of extreme risk in the equity market - the last two times it did this the equity market lost half its value in the ensuing period. We flagged this for the first time back in May of this year. The second point is that margin debt trends tend to exhibit high degrees of autocorrelation. In other words, the last few months’ change in margin debt is the best predictor of the change we’ll see in the next few months. This is important because it means that margin debt, which retraced back to +0.43 standard deviations in September, still has a long way to go. We would need to see it approach -0.5 to -1.0 standard deviations before the trend reversed. There’s plenty of room for short/intermediate term reversals within this broader secular move, as we saw in October’s print of +0.78 standard deviations. But overall, this setup represents a material headwind for the market.
One limitation of this series is that it is reported on a lag. The chart shows data through October.
Joshua Steiner, CFA
Allison Kaptur
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