*European sovereign swaps tightened last week, with Spanish swaps tightening the most (-6.9%) and Irish swaps tightening the least (-2.85%). While Spanish sovereign swaps saw tightening, most Spanish bank swaps continued to widen out.
* We published a note last week titled "Don't Be Fooled - Counterparty Risk is Rising" where we cautioned against using the Euribor-OIS spread as a measure of interbank lending within the Eurozone. We looked at the relationship between the Euribor-OIS spread and French Bank CDS. It is evident from the results that the relationship between these two data series has been falling apart since mid-march. We now think the Euribor-OIS spread is a potentially dangerous and misleading risk indicator, which is understating the underlying risks. For reference, the Euribor-OIS was roughly flat over last week, while the TED spread continued to fall.
Financial Risk Monitor Summary
• Short-term(WoW): Positive / 5 of 12 improved / 0 out of 12 worsened / 7 of 12 unchanged
• Intermediate-term(WoW): Negative / 3 of 12 improved / 3 out of 12 worsened / 6 of 12 unchanged
• Long-term(WoW): Negative / 3 of 12 improved / 3 out of 12 worsened / 6 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 WoW: AXP, PRU, AIG
Widened the most WoW: MTG, RDN, MBI
Tightened the most MoM: COF, MBI, AIG
Widened the most MoM: BAC, RDN, XL
2. European Financial CDS - Bank swaps were tighter in Europe last week for 24 of the 39 reference entities. The median tightening was 2.6%. Spanish banks continued to see their default probabilities rise notably week over week.
3. European Sovereign CDS – European Sovereign Swaps mostly tightened over last week. Spanish sovereign swaps tightened by 6.9% (-35 bps to 475 ). Irish swaps tightened the least, declining 2.85% (-17 bps to 570).
4. High Yield (YTM) Monitor – High Yield rates fell -14.4 bps last week, ending the week at 7.23 versus 7.37 the prior week.
5. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 4.7 points last week, ending at 1660.
6. TED Spread Monitor – The TED spread fell 2.0 points last week, ending the week at 37.69 this week versus last week’s print of 39.70.
7. Journal of Commerce Commodity Price Index – The JOC index rose 4.6 points, ending the week at -5.54 versus -10.1 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 less than one basis point to 39 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. This week we moved from tracking the 14-V1 tenor to tracking the 16-V1 tenor basket. Last week spreads tightened, ending the week at 145 bps.
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 89 points, ending the week at 1156 versus 1067 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 168 bps, 2 bps tighter than a week ago.
13. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 0.3% upside to TRADE resistance and 1.2% downside to TRADE support.
Margin Debt - March: +0.91 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 March.
Joshua Steiner, CFA
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