Key Takeaways:
* Spain and its banks are getting worse. Spanish bank default swaps were materially wider week-over-week, rising an average 74 bps, or 18%. All six of Spain's major banks, on which swaps trade, are trading well over 300 bps (the "Lehman line"). Spanish Sovereign swaps widened by 27 bps to 427 bps. While most investors are focused on the rapid deterioration taking place in Portugal, we think Spain is the one to watch more closely. Will 2012 be a redux of 2011 on the Europe front, this time with Spain playing the lead role? Looking at sovereign and bank swaps of a country in conjunction has generally been a solid cointegrated risk measure.
* Euribor-OIS continues to improve. It fell 3.5 bps to 44.7 on Friday. The Euribor-OIS spread is moving closer to re-normalized levels of 30-35. Meanwhile, the TED spread rose 1 point WoW, ending at 39.9.
* Both American and European Bank Default Swaps were wider over last week.
* The MCDX measure of municipal default risk fell sharply week over week, ending last week at a YTD low.
* Bullish Short-Term Quantitative Setup - Our Macro team’s quantitative setup in the XLF shows that there is 1.9% short-term upside in the XLF vs. 0.4% short-term downside.
Financial Risk Monitor Summary
• Short-term(WoW): Neutral / 3 of 12 improved / 3 out of 12 worsened / 6 of 12 unchanged
• Intermediate-term(WoW): Positive / 6 of 12 improved / 2 out of 12 worsened / 4 of 12 unchanged
• Long-term(WoW): Negative / 3 of 12 improved / 4 out of 12 worsened / 5 of 12 unchanged
1. US Financials CDS Monitor – Swaps widened for 22 of 27 major domestic financial company reference entities last week.
Widened the most WoW: GS, AGO, MBI
Tightened the most WoW: MTG, RDN, HIG
Widened the most MoM: MBI, MMC, AON
Tightened the most MoM: BAC, WFC, AIG
2. European Financials CDS Monitor – Bank swaps were wider in Europe last week for 35 of the 40 reference entities. The average widening was 5.6% and the median widening was 6.0%.
3. European Sovereign CDS – European Sovereign Swaps mostly tightened over last week. American sovereign swaps tightened by 7.2% (-2 bps to 30 ) and Spanish sovereign swaps widened by 6.6% (27 bps to 427).
4. High Yield (YTM) Monitor – High Yield rates rose 12.4 bps last week, ending the week at 7.13 versus 7.01 the prior week.
5. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 1.93 points last week, ending at 1648.
6. TED Spread Monitor – The TED spread rose 1.0 point last week, ending the week at 40 versus last week’s print of 39.
7. Journal of Commerce Commodity Price Index – The JOC index was flat week over week, ending Thursday at -7.7. Data was not available for Friday.
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 45 bps.
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 tightened , ending the week at 110 bps versus 115 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 34 points, ending the week at 908 versus 874 the prior week.
12. 2-10 Spread – We track the 2-10 spread as an indicator of bank margin pressure. Last week the 2-10 spread tightened to 188 bps, 5 bps tighter than a week ago.
13. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 1.9% upside to TRADE resistance and 0.4% downside to TRADE support.
Margin Debt - February: +0.85 standard deviations
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, it 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. 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. Overall, however, this setup represents a long-term headwind for the market. One limitation of this series is that it is reported on a lag. The chart shows data through February.
Joshua Steiner, CFA
Allison Kaptur
Robert Belsky
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