* The Greek election. New Democracy, the pro-bailout/pro-austerity party, received the plurality of the vote on Sunday with 29.7%, eclipsing Syriza by roughly 2.5%. PASOK, the center-left party, took 12.3% of the total vote, which means New Democracy and PASOK together should be able to clear the 151-seat hurdle necessary to hold a majority of the legislature. Recall that in the May 6 election they fell short of the 151-vote threshold by 2 votes. As such, a Greek exit of the Eurozone has been delayed, and some measure of relief rally should be expected.
That said, Spanish and Italian CDS widened, rising 5.3% (+31 bps) and 3.0% (+16 bps), respectively. So, while Greece's election was viewed as a potential downside catalyst, it hasn't changed the negative reality facing either Spain or Italy's economy, or Greece's for that matter. While expectations are now high for austerity terms on Greece to be eased, the current rate of contraction in the Greek economy will make it all but impossible to comply with even reduced terms in the intermediate to long-term.
* Yield spread continues to flatten. The 2-10 spread tightened to 129 bps. If spreads hold where they are now, the 3Q12 sequential change will rival what we saw in 3Q11, an ominous sign for bank margins.
* XLF quantitative setup – Our Macro team’s quantitative setup in the XLF shows 0.6% upside to TRADE resistance of $14.43 and 1.7% downside to TRADE support of $14.10.
Financial Risk Monitor Summary
• Short-term(WoW): Neutral / 3 of 12 improved / 3 out of 12 worsened / 7 of 12 unchanged
• Intermediate-term(WoW): Negative / 3 of 12 improved / 5 out of 12 worsened / 5 of 12 unchanged
• Long-term(WoW): Neutral / 4 of 12 improved / 4 out of 12 worsened / 5 of 12 unchanged
1. US Financials CDS Monitor – Swaps tightened for 21 of 27 major domestic financial company reference entities last week.
Tightened the most WoW: WFC, GS, MS
Widened the most WoW: LNC, UNM, AGO
Tightened the most MoM: WFC, GS, MS
Widened the most MoM: UNM, AGO, MMC
2. European Financial CDS - 26 of the 39 reference entities we track showed spreads widening across Europe last week. To be clear, these results are from last Friday, a few days before the Greek Election.
3. Asian Financial CDS - 10 out of 12 Asian banks swaps were tighter last week.
4. Sovereign CDS – European Sovereign Swaps mostly tightened over last week. French sovereign swaps tightened by 8.0% (-17 bps to 195 ) and Spanish sovereign swaps widened by 5.3% (31 bps to 609).
5. High Yield (YTM) Monitor – High Yield rates fell 6.3 bps last week, ending the week at 7.87 versus 7.93 the prior week.
6. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 3.37 points last week, ending at 1645.
7. TED Spread Monitor – The TED spread fell 1.5 points last week, ending the week at 37.4 this week versus last week’s print of 38.9.
8. Journal of Commerce Commodity Price Index – The JOC index fell 0.7 points, ending the week at -15.88 versus -15.2 the prior week.
9. 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 widened by 2 bps to 41 bps.
10. 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.
11. 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 162 bps versus 169 bps the prior week.
12. Chinese Steel - We use Chinese steel rebar prices to gauge Chinese construction activity. We look at the average Chinese rebar spot price. Steel prices in China rose 0.27% last week, or 11 yuan/ton, to 4,079 yuan/ton. Notably, Chinese steel rebar prices have been generally moving lower since August of last year.
13. 2-10 Spread – We track the 2-10 spread as an indicator of bank margin pressure. Last week the 2-10 spread tightened to 129 bps, 7 bps tighter than a week ago.
14. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 0.6% upside to TRADE resistance and 1.7% downside to TRADE support.
Margin Debt - April: +0.93 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 April.
Joshua Steiner, CFA
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