• It's Coming...

    MARKET EDGES

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Takeaway: While China's steel prices break still lower, U.S. Financials bailout speculation-driven momentum wanes. We're getting down to crunch time.

* The U.S. financials rallied further last week, but in much more subdued fashion with the XLF up 0.4%. The XLF remains the only sector still broken from a TREND standpoint (intermediate term) on our macro team's quantitative setup. 

* European financials acted a lot like European sovereigns, both tightening week over week. The Draghi rally continues for now.

* Meanwhile, on the other side of Earth, steel prices in China fell another 1.2% last week, or 44 yuan/ton, to 3,622 yuan/ton. In the last few months, Chinese construction steel prices have fallen ~10%. This index is reflecting significant weakness in China's construction market.

* Last week the 2-10 spread widened 8 bps last week to 140 bps, and is now up more than 20 bps from its late July lows. After the battering net interest margins took in 2Q, this is a positive development, on the margin. That said, the 2-10 spread averaged 151 bps in 2Q12, so even with the rally of the last few weeks it is still trending down 20 bps QoQ thus far in 3Q. 

* Our Macro team’s quantitative setup in the XLF shows 0.7% upside to TREND resistance of  $14.90 and 0.9% downside to TRADE support of $14.57.

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 / 8 of 12 improved / 2 out of 12 worsened / 3 of 12 unchanged  

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

MONDAY MORNING RISK MONITOR: RALLY MOMENTUM FADING, TROUBLE BREWS IN THE EAST - Summary

1. US Financials CDS Monitor – Credit default swaps across U.S. financials were tighter week over week. Overall, 25 out 27 reference entities that we track saw credit default swaps tighten last week.

Tightened the most WoW:  MTG, RDN, LNC

Widened the most/ tightened the least WoW: GS, UNM, MBI

Tightened the most MoM: MMC, AIG, ALL

Widened the most MoM: GNW, UNM, MTG

MONDAY MORNING RISK MONITOR: RALLY MOMENTUM FADING, TROUBLE BREWS IN THE EAST - American 

2. European Financial CDS - French and Italian banks tightened, alongside the sovereigns. Spanish banks were mixed, with a few of them posting sizable widening. Overall, however, swaps throughout Europe's financial system were notably tighter. 

MONDAY MORNING RISK MONITOR: RALLY MOMENTUM FADING, TROUBLE BREWS IN THE EAST - Europe

3. Asian Financial CDS - 10 of 12 reference entities we track across Asia had tighter credit default swaps week over week. 

MONDAY MORNING RISK MONITOR: RALLY MOMENTUM FADING, TROUBLE BREWS IN THE EAST - Asia 

4. Sovereign CDS – Sovereign swaps were tighter around the globe last week. Portugal, Spain and Italy all saw their sovereign swaps tighten by more than 9%.

MONDAY MORNING RISK MONITOR: RALLY MOMENTUM FADING, TROUBLE BREWS IN THE EAST - Sov Table

MONDAY MORNING RISK MONITOR: RALLY MOMENTUM FADING, TROUBLE BREWS IN THE EAST - Sov 1

MONDAY MORNING RISK MONITOR: RALLY MOMENTUM FADING, TROUBLE BREWS IN THE EAST - Sov 2

5. High Yield (YTM) Monitor – High Yield continues to tighten, as rates fell another 2 bps last week, ending the week at 7.07% versus 7.09% the prior week.

MONDAY MORNING RISK MONITOR: RALLY MOMENTUM FADING, TROUBLE BREWS IN THE EAST - HY

6. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 4.6 points last week, ending at 1693.

MONDAY MORNING RISK MONITOR: RALLY MOMENTUM FADING, TROUBLE BREWS IN THE EAST - LLI

7. TED Spread Monitor – The TED spread fell 3 bps last week, ending the week at 33.3 bps this week versus last week’s print of 36.08.

MONDAY MORNING RISK MONITOR: RALLY MOMENTUM FADING, TROUBLE BREWS IN THE EAST - TED

8. Journal of Commerce Commodity Price Index – The JOC index rose 4.2 points, ending the week at -5.59 versus -9.8 the prior week.

MONDAY MORNING RISK MONITOR: RALLY MOMENTUM FADING, TROUBLE BREWS IN THE EAST - JOC

9. Euribor-OIS spread –  The Euribor-OIS spread tightened by 3 bps to 28 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: RALLY MOMENTUM FADING, TROUBLE BREWS IN THE EAST - 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: RALLY MOMENTUM FADING, TROUBLE BREWS IN THE EAST - ECB

11. Markit MCDX Index Monitor – Last week spreads tightened 10 bps, ending at 141 bps versus last Friday's print of 151 bps the prior week. 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. 

MONDAY MORNING RISK MONITOR: RALLY MOMENTUM FADING, TROUBLE BREWS IN THE EAST - MCDX

12. Chinese Steel – Steel prices in China fell 1.2% last week, or 44 yuan/ton, to 3,622 yuan/ton. In the last few months, Chinese construction steel prices have fallen ~10%. This index is reflecting significant weakness in China's construction market. 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: RALLY MOMENTUM FADING, TROUBLE BREWS IN THE EAST - CHIS

13. 2-10 Spread –  Last week the 2-10 spread widened 8 bps last week to 140 bps, and is now up more than 20 bps from its late July lows. We track the 2-10 spread as an indicator of bank margin pressure. 

MONDAY MORNING RISK MONITOR: RALLY MOMENTUM FADING, TROUBLE BREWS IN THE EAST - 2 10

14. Our Macro team’s quantitative setup in the XLF shows 0.7% upside to TREND resistance of  $14.90 and 0.9% downside to TRADE support of $14.57.

MONDAY MORNING RISK MONITOR: RALLY MOMENTUM FADING, TROUBLE BREWS IN THE EAST - 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: RALLY MOMENTUM FADING, TROUBLE BREWS IN THE EAST - NYSE margin debt

Joshua Steiner, CFA

Robert Belsky

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