* Interbank risk continues to recede - Euribor-OIS, our preferred measure of systemic risk in the European banking system, tightened 5 bps to 71 bps last week. There is a similar trend occurring in the TED spread, which fell by 3 basis points to 42 bps last week. The next round of LTRO is scheduled for later this month (February 29). This should provide an ongoing tailwind to the interbank market, as it was the last round of LTRO that sparked the move in Euribor-OIS from 98 bps to 71 bps. This should be an ongoing catalyst for reflating the discount at the large-cap US financials. For more details on quantifying that reflation, see our recent notes on the subject.
* Bank CDS was mostly wider in both Europe and America last week, with the notable exception of Greek banks whose spreads tightened.
* Sovereign European CDS were mixed. The most notable takeaway is the ongoing sharp reversal in Portuguese sovereign swaps.
* Bullish Quantitative Set Up - Our firm's Macro quantitative model indicates that there is more updside than downside in the short term (2.9% upside in the XLF vs. 0.3% downside).
Financial Risk Monitor Summary
• Short-term(WoW): Positive / 4 of 12 improved / 2 out of 12 worsened / 6 of 12 unchanged
• Intermediate-term(WoW): Positive / 8 of 12 improved / 2 out of 12 worsened / 2 of 12 unchanged
• Long-term(WoW): Negative / 1 of 12 improved / 7 out of 12 worsened / 4 of 12 unchanged
1. US Financials CDS Monitor – Swaps widened for 24 of 27 major domestic financial company reference entities last week.
Widened the most WoW: JPM, AXP, XL
Tightened the most WoW: RDN, MTG, AGO
Widened the most MoM: MBI, COF, MTG
Tightened the most MoM: AIG, GNW, MS
2. European Financials CDS Monitor – Bank swaps were wider in Europe last week for 26 of the 40 reference entities. The median widening was 10.1%.
3. European Sovereign CDS – European Sovereign Swaps came in mixed last week. Portuguese sovereign swaps tightened by 11.5% (-148 bps to 1136 ) and French sovereign swaps widened by 6.8% (11 bps to 174).
4. High Yield (YTM) Monitor – High Yield rates fell 8.0 bps last week, ending the week at 7.37 versus 7.45 the prior week.
5. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 2 points last week, ending at 1635.
6. TED Spread Monitor – The TED spread fell 3 points last week, ending the week at 42.2 this week versus last week’s print of 45.3.
7. Journal of Commerce Commodity Price Index – The JOC index rose 3.0 points, ending the week at -9.54 versus -12.5 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 4.7bps to 70.9 bps over last Monday.
9. ECB Liquidity Recourse to the Deposit Facility – The ECB Liquidity Recourse to the Deposit Facility measures banks’ overnight deposits with the ECB. Taken in conjunction with excess reserves, the ECB deposit facility measures excess liquidity in the Euro banking system. An increase in this metric shows that banks are borrowing from the ECB. In other words, the deposit facility measures one element of the ECB response to the crisis.
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 widened, ending the week at 123 bps versus 121 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. Last week the index rose 68 points, ending the week at 715 versus 647 the prior week.
12. 2-10 Spread – We track the 2-10 spread as an indicator of bank margin pressure. The 2-10 spread widened to 171 bps, 2 bps wider than a week ago.
13. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 2.9% upside to TRADE resistance and 0.2% downside to TRADE support.
NYSE Margin Debt - December
We publish NYSE Margin Debt every month when it’s released. NYSE Margin debt hit its post-2007 peak in April of 2011 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 last 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 2011. 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 +0.53 standard deviations in November, still has a long way to go. We would need to see it approach -0.5 to -1.0 standard deviations before the trend runs its course. There’s plenty of room for short/intermediate term reversals within this broader secular move, as we saw in November and December's print of +0.55 and +0.53 standard deviations. Overall, however, this setup represents a headwind for the market. One limitation of this series is that it is reported on a lag. The chart shows data through December.
Joshua Steiner, CFA
Trouble viewing the charts in this email? Please click the link at the bottom of the note to view in your browser