* Last week saw the largest single week of improvement in credit default swaps ever for EU sovereign credits on the heels of the ECB's Draghi pledging "unlimited" asset purchases. Spanish, Italian, German and French bank as well as sovereign credit default swaps were sharply lower, reflecting optimism that the ECB will avert the crisis.
* High yield and leveraged loans found renewed bids last week, pushing both indices to new, post-crisis highs.
* Commodities were similarly affected. The JOC index turned higher again this week. Expect higher prices at the pump and at the grocery store.
* China seems to be the only country left out of the global rally - Chinese steel fell another 3.4% WoW.
* Negative Short-term Setup: In spite of last week's impressive squeeze higher, our Macro team’s quantitative setup in the XLF shows a negative short-term setup with 0.4% upside to TRADE resistance of 15.74 and 2.9% downside to TRADE support of 15.23.
Financial Risk Monitor Summary
• Short-term(WoW): Positive / 9 of 12 improved / 1 out of 12 worsened / 3 of 12 unchanged
• Intermediate-term(WoW): Positive / 8 of 12 improved / 2 out of 12 worsened / 3 of 12 unchanged
• Long-term(WoW): Positive / 8 of 12 improved / 2 out of 12 worsened / 3 of 12 unchanged
1. American Financial CDS – Credit default swaps tightened sharply last week across all U.S. Financial institutions. Some of the most improved were BAC & C with 17-18% declines week-over-week along with GS down 15% WoW. Currently, none of the big six banks/brokers are trading north of 300 bps.
Tightened the most WoW: BAC, C, GS
Tightened the least WoW: MBI, AGO, TRV
Tightened the most WoW: BAC, C, GS
Tightened the least MoM: TRV, COF, ALL
2. European Financial CDS – Italian, German, French and British bank default swaps were down approximately 20% across the board last week, on ECB commentary.
3. Asian Financial CDS – Chinese and Indian bank CDS tightened while Japanese banks were mixed.
4. Sovereign CDS – European sovereign default swaps plunge. Spanish and Italian sovereign default swap premiums fell by 33% week-over-week on the ECB's "unlimited" pledge. Ireland saw its swaps decline 24%, while Portuguese swaps fell 20%. Even France and Germany benefited with 16% declines each.
5. High Yield (YTM) Monitor – High Yield rates fell 20 bps last week, ending the week at 6.86% versus 7.06% the prior week.
6. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 7.2 points last week, ending at 1,716.
7. TED Spread Monitor – The TED spread fell 4 bps last week, ending the week at 30 bps versus 34 bps last week.
8. Journal of Commerce Commodity Price Index – The JOC index rose 3.0 points, ending the week at +1.0 versus -2.0 the prior week. This is the first time the index has been positive since August 8th 2011.
9. Euribor-OIS spread – The Euribor-OIS spread tightened by 3 bps to 18 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 2 bps, ending the week at 152 bps versus 154 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 3.4% last week, or 118 yuan/ton, to 3388 yuan/ton. Over the last four months, Chinese construction steel prices have fallen ~20%. This index continues to reflect 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 – Last week the 2-10 spread widened to 141 bps, 9 bps wider than a week ago. We track the 2-10 spread as an indicator of bank margin pressure.
14. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 0.4% upside to TRADE resistance and 2.9% downside to TRADE support.
Margin Debt - July: +0.61 standard deviations
NYSE Margin debt fell to $278 billion in July from $285 billion in June. We like to to look at margin debt levels as a broad contrarian sentiment indicator. For reference, our approach is to look at margin debt levels in standard deviation terms over the period 1. Our analysis finds 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 significant risk in the equity market. The preceding two instances were followed by the equity market losing roughly half its value over the following 24-36 months. 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 July.
Joshua Steiner, CFA
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