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Key Takeaways

* Last week was interesting as rising confidence around an ECB-led bailout gave way to disappointment, only to be followed by an extraordinary rally on better than expected US econ data. All told, both Sovereign and company-specific default swaps were broadly tighter last week. 

*The average rate on high yield corporate debt dropped 20 bps last week, another sign that the market thinks risk is off the table in the short-term.


* The MCDX index fell significantly last week. We remain puzzled by this considering the recent spate of muni bankruptcy filings.

* XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 0.5% upside to TREND resistance of  $14.89 and 1.8% downside to TRADE support of $14.56. The XLF is currently bullish TRADE, bearish TREND.

Financial Risk Monitor Summary  

• Short-term(WoW): Positive / 7 of 12 improved / 1 out of 12 worsened / 5 of 12 unchanged  

• Intermediate-term(WoW): Positive / 5 of 12 improved / 2 out of 12 worsened / 6 of 12 unchanged  

• Long-term(WoW): Positive / 6 of 12 improved / 3 out of 12 worsened / 4 of 12 unchanged

MONDAY MORNING RISK MONITOR: RISK TAKES A HOLIDAY, FOR NOW - Summary 

1. US Financials CDS Monitor – The money center banks (JPM, BAC, C, WFC) and the large U.S. brokers (GS, MS) all saw credit default swaps tighten again last week.

Tightened the most WoW: RDN, AIG, MMC

Widened the mos WoW: COF, MTG, GNW

Tightened the most MoM: MET, ALL, XL

Widened the most MoM: MTG, MBI, GNW

MONDAY MORNING RISK MONITOR: RISK TAKES A HOLIDAY, FOR NOW - American CDS

2. European Financial CDS - Spanish, German, French, Italian and Greek banks tightened.  Overall, 37 of the 39 European financial reference entities we track saw spreads tighten last week.

MONDAY MORNING RISK MONITOR: RISK TAKES A HOLIDAY, FOR NOW - European Financials

3. Asian Financial CDS -  China and India posted notable tightening, while Japanese financials were largely flat. 

MONDAY MORNING RISK MONITOR: RISK TAKES A HOLIDAY, FOR NOW - Asia CDS

4. Sovereign CDS – European Sovereign Swaps tightened across the board last week. In Europe, French sovereign swaps tightened the most:  -18 bps to 154 bps while Portuguese sovereign swaps tightened the least: -4 bps to 852 bps.

MONDAY MORNING RISK MONITOR: RISK TAKES A HOLIDAY, FOR NOW - Sov Table

MONDAY MORNING RISK MONITOR: RISK TAKES A HOLIDAY, FOR NOW - Sov CDS 1

MONDAY MORNING RISK MONITOR: RISK TAKES A HOLIDAY, FOR NOW - Sov CDS 2

5. High Yield (YTM) Monitor – High Yield rates fell 20 bps last week, ending the week at 7.09 versus 7.29 the prior week.

MONDAY MORNING RISK MONITOR: RISK TAKES A HOLIDAY, FOR NOW - High Yield

6. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 5.15 points last week, ending at 1689.

MONDAY MORNING RISK MONITOR: RISK TAKES A HOLIDAY, FOR NOW - LLI

7. TED Spread Monitor – The TED spread rose 1.8 points last week, ending the week at 36.1 this week versus last week’s print of 34.3.

MONDAY MORNING RISK MONITOR: RISK TAKES A HOLIDAY, FOR NOW - TED

8. Journal of Commerce Commodity Price Index – The JOC index was flat, ending the week at -9.8. 

MONDAY MORNING RISK MONITOR: RISK TAKES A HOLIDAY, FOR NOW - JOC

9. Euribor-OIS spread – The Euribor-OIS spread tightened by 6 bps to 29 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. 

MONDAY MORNING RISK MONITOR: RISK TAKES A HOLIDAY, FOR NOW - Euribor OIS

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.  

MONDAY MORNING RISK MONITOR: RISK TAKES A HOLIDAY, FOR NOW - ECB

11. Markit MCDX Index Monitor – Last week, MCDX spreads tightened by 12 bps, the index ended the week at 151 bps. The Markit MCDX is a measure of municipal credit default swaps. We believe this index is a useful indicator of pressure at the state and local government level. 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. 

MONDAY MORNING RISK MONITOR: RISK TAKES A HOLIDAY, FOR NOW - MCDX

12. Chinese Steel – Steel prices in China were flat last week at 3,666 yuan/ton, though in the last few months Chinese construction steel prices are down ~10%. 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.    

MONDAY MORNING RISK MONITOR: RISK TAKES A HOLIDAY, FOR NOW - CHIS

13. 2-10 Spread – Last week the 2-10 spread widened 2 bps week-over-week to 132 bps. We use the 2-10 yield spread as a broad measure of bank margin pressure.  

MONDAY MORNING RISK MONITOR: RISK TAKES A HOLIDAY, FOR NOW - 2 10

14. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 0.5% upside to TREND resistance of  $14.89 and 1.8% downside to TRADE support of $14.56. The XLF is currently bullish TRADE, bearish TREND.

MONDAY MORNING RISK MONITOR: RISK TAKES A HOLIDAY, FOR NOW - XLF

Margin Debt - June: +0.72 standard deviations 

NYSE Margin debt rose in June to $285 billion from $279 billion in May. 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 June. 

MONDAY MORNING RISK MONITOR: RISK TAKES A HOLIDAY, FOR NOW - NYSE margin debt

Joshua Steiner, CFA

Robert Belsky

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