Key Takeaways
* European bank swaps were a mixed batch last week. German, Spanish, and French banks saw broad tightening last week while Italian and Greek banks widened. Sovereign swaps moved alongside bank swaps this week with most European countries tightening except for Ireland. US Bank swaps were generally uneventful last week.
* Chinese steel prices dropped sharply last week. We use this indicator as a proxy for the health of China's construction industry.
* The yield curve continues to flatten. How low can the 10-year go? More margin pressure to come in 3Q on the heels of sharp 2Q drops in NIM for JPM (-14 bps) and C (-9 bps).
*XLF Macro Quantitative Setup – More downside than upside. Our Macro team’s quantitative setup in the XLF shows 1.1% upside to TREND resistance of $14.87 and 2.7% downside to TRADE support at $14.31.
Financial Risk Monitor Summary
• Short-term(WoW): Negative / 2 of 12 improved / 3 out of 12 worsened / 8 of 12 unchanged
• Intermediate-term(WoW): Positive / 8 of 12 improved / 3 out of 12 worsened / 2 of 12 unchanged
• Long-term(WoW): Positive / 5 of 12 improved / 2 out of 12 worsened / 6 of 12 unchanged
1. US Financials CDS Monitor – Swaps were flat to mixed for the large cap US financials. Meanwhile, swaps widened sharply for mortgage insurers (MTG, RDN, GNW) and guarantors (AGO, MBI).
Tightened the most WoW: JPM, WFC, SLM
Widened the mos WoW: MTG, RDN, MBI
Tightened the most MoM: JPM, WFC, RDN
Widened the most/ tightened the least MoM: MTG, UNM, GNW
2. European Financial CDS - Spanish banks tightened a lot while French banks tightened a little. Italian banks were a bit wider while Greek banks widened a lot. Overall, 20 of the 39 European financial reference entities we track saw spreads widened last week.
3. Asian Financial CDS - 9 of the 12 Asian financials we track saw swaps widen last week. China's banks widened 5-9 bps.
4. Sovereign CDS – All of Europe tightened, except for Ireland.
5. High Yield (YTM) Monitor – High Yield rates rose 4.6 bps last week, ending the week at 7.39 versus 7.34 the prior week.
6. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 11.3 points last week, ending at 1678.
7. TED Spread Monitor – The TED spread fell 1.5 points last week, ending the week at 36.9 this week versus last week’s print of 38.4.
8. Journal of Commerce Commodity Price Index – The JOC index fell 1.8 points, ending the week at -12.37 versus -10.6 the prior week.
9. Euribor-OIS spread – The Euribor-OIS spread tightened by 3 bps to 38 bps. 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.
10. ECB Liquidity Recourse to the Deposit Facility – This index fell sharply from precipitous heights on the first day that the new 0.00% deposit rate went into effect. 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 – Municipal spreads tightened 1 basis point last week, ending at 158 bps. Given the spate of bankruptcies in the last few weeks, we're suprised the MCDX is as benign as it is. 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 16-V1.
12. Chinese Steel - Steel prices in China fell 2.19% last week, or 88 yuan/ton, to 3,928 yuan/ton. Notably, Chinese steel rebar prices have been generally moving lower since August of last year. We use Chinese steel rebar prices to gauge Chinese construction activity, and, by extension, the health of the Chinese economy. We look at the average Chinese rebar spot price.
13. 2-10 Spread – Last week the 2-10 spread tightened to 124 bps, 3 bps tighter than a week ago. While admittedly imperfect, we think this is a useful reference for bank margin pressure.
14. XLF Macro Quantitative Setup – More downside than upside. Our Macro team’s quantitative setup in the XLF shows 1.1% upside to TREND resistance of $14.87 and 2.7% downside to TRADE support at $14.31.
Margin Debt - May: +0.63 standard deviations
NYSE Margin debt fell in May to $279 billion from $298 billion in April. We like to to look at margin debt levels as a broad contrarian sentiment indicator. For reference, our approach is to look at it margin debt levels in standard deviation terms over the period 1. Our analysis shows that when margin debt gets to +1.5 standard deviations or greater, as it did in April of 2011, it has historically been a signal of extreme risk in the equity market. The preceding two instances were followed by the equity market losing roughly half its value. Overall 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 May.
Joshua Steiner, CFA
Robert Belsky
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