Highlights from this week's Risk Monitor
* The TED spread rose by less than one basis point to 57.6 bps and the Euribor/OIS tightened 4 bps vs last week. These are important gauges of perceived risk among interbank participants, currently showing contradictory signals.
* Bank swaps in the U.S. tightened significantly, while European bank CDS continued to widen out.
* The MCDX measure of municipal default risk fell sharply week over week.
* The ECB Liquidity Recourse to the Deposit Facility continued to climb.
* Slightly More Downside - Our macro quantitative model indicates that on a short term duration (TRADE), there is slightly more downside risk in the XLF (1.5% downside vs. 1.3% upside).
Financial Risk Monitor Summary
• Short-term(WoW): Positive / 5 of 12 improved / 3 out of 12 worsened / 4 of 12 unchanged
• Intermediate-term(WoW): Negative / 3 of 12 improved / 4 out of 12 worsened / 5 of 12 unchanged
• Long-term(WoW): Negative / 1 of 12 improved / 9 out of 12 worsened / 2 of 12 unchanged
1. US Financials CDS Monitor – Swaps tightened for 25 of 27 major domestic financial company reference entities last week.
Tightened the most WoW: AGO, MMC, MBI
Widened the most/ tightened the least WoW: MTG, RDN, SLM
Tightened the most MoM: MBI, AGO, MMC
Widened the most MoM: C, SLM, MTG
2. European Financials CDS Monitor – Bank swaps were wider in Europe last week for 29 of the 40 reference entities. The average widening was 2.5% and the median widening was 7.2%
3. European Sovereign CDS – European Sovereign Swaps mostly widened over last week. Irish sovereign swaps tightened by 4.1% (-30 bps to 696 ) and Spanish sovereign swaps widened by 15.2% (58 bps to 439)
4. High Yield (YTM) Monitor – High Yield rates fell -66 bps last week, ending the week at 8.20 versus 8.86 the prior week.
There appear to be data integrity issues associated with the month of December in this series such that this week's result can't be taken at face value.
5. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 14 points last week, ending at 1597.
6. TED Spread Monitor – The TED spread rose less than 1 basis point last week, ending the week at 57.6 this week versus last week’s print of 57.1.
7. Journal of Commerce Commodity Price Index – The JOC index rose 4 points, ending the week at -20 versus -24 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 4 bps to 94 bps.
9. 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. Over the course of the last few months, this metric has been making higher highs and higher lows, a pattern that continued last week.
10. 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 tightened 26 bps, ending the week at 154 bps versus 180 bps the prior week.
11. 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. The Baltic Dry Index has fallen 391 points since December 23rd and ended this week at 1347.
12. 2-10 Spread – We track the 2-10 spread as an indicator of bank margin pressure. Last week the 2-10 spread widened to 170 bps, 6 bps wider than a week ago.
13. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 1.3% upside to TRADE resistance and 1.5% downside to TRADE support.
Margin Debt in November
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 and November’s print of +0.78 and +0.55 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 November.
Joshua Steiner, CFA
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