Key Takeaways
* Europe takes a breather from its rally. Germany, France, Italy and Spain all saw material widening in their sovereign swaps last week. Rising uncertainty around both Germany's economic health and Spain and Italy's ability to manage through the crisis without recession-inducing austerity commitments weighed on the continent's outlook. The relative winners this week were Portugal and Ireland. Portuguese and Irish sovereign swaps tightened by 53 bps and 8 bps, respectively.
* Warren Buffett accomplishes what three California municipal bankruptcies cannot. Finally, the MCDX gauge of municipal bond default risk widens.
* Chinese steel prices continue to steamroll lower, falling another 2.0% last week, underscoring the growing weakness in China's construction market.
* The 2-10 spread contracted by 12 bps WoW, taking back much of the improvement seen in 3Q. This marked the first real retrenchment in the last month and a half.
* Our Macro team’s quantitative setup in the XLF shows 1.0% upside to TRADE resistance and 0.2% downside to TRADE support.
Financial Risk Monitor Summary
• Short-term(WoW): Negative / 2 of 12 improved / 4 out of 12 worsened / 7 of 12 unchanged
• Intermediate-term(WoW): Positive / 9 of 12 improved / 3 out of 12 worsened / 1 of 12 unchanged
• Long-term(WoW): Positive / 8 of 12 improved / 2 out of 12 worsened / 3 of 12 unchanged
1. American Financial CDS - Swaps widened narrowly at the money center banks and large brokers. Overall, swaps tightened for 17 out of 27 domestic financial institutions.
Tightened the most WoW: RDN, LNC, GNW
Widened the most WoW: COF, MTG, JPM
Tightened the most WoW: RDN, LNC, JPM
Widened the most/ tightened the least MoM: MTG, COF, UNM
2. European Financial CDS - German bank swaps widen while Spanish bank swaps tighten.
3. Asian Financial CDS - Chinese and Indian bank default swaps were narrowly wider WoW while Japanese bank swaps were generally flat.
4. European Sovereign CDS – Germany, France, Italy and Spain all saw material widening in their sovereign swaps. Rising uncertainty around both Germany's economic health and Spain and Italy's ability to manage through the crisis without recession-inducing austerity commitments weighed on the continent's outlook. The winners this week were Portugal and Ireland. Portuguese and Irish sovereign swaps tightened by 53 bps and 8 bps, respectively.
5. High Yield (YTM) Monitor – High yield rates fell 1 basis point last week, ending at 7.14 versus 7.15 the prior week.
6. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 5 points last week, ending at 1704.
7. TED Spread – The TED spread fell 4 bps last week, ending the week at 33 bps this week versus last week’s print of 37 bps.
8. Journal of Commerce Commodity Price Index – The JOC index rose 4.6 points, ending the week at -2.52 versus -7.1 the prior week.
9. Euribor-OIS spread – The Euribor-OIS spread tightened by 4 bps to 22 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, on the news that Buffett was reducing his risk exposure to the municipal market, MCDX spreads widened 11 bps, ending the week at 150 bps versus 139 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 fell 2.0% last week, or 72 yuan/ton, to 3549 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 – We track the 2-10 spread as an indicator of bank margin pressure. Last week the 2-10 spread tightened by 12 bps to 141 bps. This marks its first real week of reversal in the last month and a half.
14. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 1.0% upside to TRADE resistance and 0.2% downside to TRADE support.
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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