Key Takeaways
* European sovereign swaps tightened further last week on positive commentary from Angela Merkel, while European bank swaps were generally wider (particularly Greek, German, Spanish and Italian banks). Unfortunately, there is a somewhat mixed track record of late with respect to whether it's the banks or the sovereigns that are the appropriate leading indicator.
* Large cap U.S. banks are definitely taking their cues from Europe's sovereigns and Merkel's commentary. Large-cap bank swaps were tighter again this week.
* The 2-10 spread widened another 13 bps, leaving it 20 bps higher on a MoM basis. This week's positive data gets the yield environment one step closer to being flat sequentially vs. 2Q12. While yield spreads are now effectively flat, the 3Q12-to-date sequential change is still meaningfully negative.
Financial Risk Monitor Summary
• Short-term(WoW): Positive / 6 of 12 improved / 1 out of 12 worsened / 6 of 12 unchanged
• Intermediate-term(WoW): Positive / 8 of 12 improved / 2 out of 12 worsened / 3 of 12 unchanged
• Long-term(WoW): Positive / 7 of 12 improved / 2 out of 12 worsened / 4 of 12 unchanged
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 week-over-week. The large-caps continue to tighten on perception of diminished risk across Europe. Interestingly, Euro banks were less enthusiastic last week, as most major EU banks widened.
Tightened the most WoW: MTG, RDN, AGO
Widened the most WoW: MET, TRV, CB
Tightened the most WoW: RDN, MMC, XL
Widened the most MoM: GNW, MTG, UNM
2. European Financial CDS - Unlike the sovereigns, the Euro banks were much more mixed last week. While French bank swaps tightened slightly, German, Italian and Spanish bank swaps were mostly wider. Greek bank swaps, meanwhile, widened considerably.
3. Asian Financial CDS - Chinese banks were notably tighter week-over-week with all three reference entities we track tightening by 10-20 bps. Meanwhile, Indian banks continue to move in the wrong direction. Japanese banks were generally tighter week-over-week, though just nominally.
4. Sovereign CDS – European sovereign swaps moved still tighter last week with Italy, Spain and Portugal contracting the most. In response, Germany and France tightened as well.
5. High Yield (YTM) Monitor – High yield rates rose 13 bps last week, ending the week at 7.16% versus 7.03% the prior week.
6. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 3.8 points last week, ending at 1697. This series continues to move up and to the right.
7. TED Spread Monitor – The TED spread rose 3 bps last week, ending the week at 35 bps.
8. Journal of Commerce Commodity Price Index – The JOC index fell 1.6 points, ending the week at -6.93 versus -5.4 the prior week.
9. Euribor-OIS spread – The Euribor-OIS spread tightened by 3 bps to 26 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 – 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 – Last week spreads tightened 3 bps, ending the week at 139 bps versus 142 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.
12. Chinese Steel - Steel prices in China rose 0.3% last week, or 12 yuan/ton, to 3633 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.
13. 2-10 Spread – The reflation in the 2-10 spread has been dramatic. Last week it tacked on another 13 bps, rising to 154 bps. Currently, the yield spread is back in line with the average for 2Q12 (151 bps), though the 3Q12-to-date average remains meaningfully down sequentially.
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.
Joshua Steiner, CFA
Robert Belsky
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