*QE3 has landed, what now? - Banks swaps and sovereign swaps in America, Europe, and Asia all tightened WoW, benefitting from the Fed's QE3 announcement on Thursday. Where do we go from here? We've profiled how the components and subsectors of the financial space in the United States have acted during the last 2 quantitative easing programs in a note entitled "Quantitative Easing Redux: Winners and Losers". In this note we provide a framework for positioning in the months ahead. The note can be found here.
*Commodity prices up, junk bond yields down - The JOC commodity index rose again WoW, marking only the second consecutive positive week for the index since the middle of 2011. Meanwhile, junk bond prices continue to make new highs.
* The 2-10 spread widened sharply WoW. Finally, some reprieve for bank margins, though it seems counterintuitive to think this can last given the amount of firepower the Fed is aiming at the long end of the curve.
* High Yield rates fell 36 bps last week, ending the week at 6.51% versus 6.86% the prior week.
* MCDX: Last week municipal default swaps tightened 16 bps, ending the week at 136 bps.
* Even Chinese steel gets a little lift - Chinese steel rose 2.6% WoW.
* Our Macro team’s quantitative setup in the XLF shows 0.6% upside to TRADE resistance and 3.2% downside to TRADE support.
Financial Risk Monitor Summary
• Short-term(WoW): Positive / 11 of 12 improved / 0 out of 12 worsened / 2 of 12 unchanged
• Intermediate-term(WoW): Positive / 9 of 12 improved / 2 out of 12 worsened / 2 of 12 unchanged
• Long-term(WoW): Positive / 7 of 12 improved / 2 out of 12 worsened / 4 of 12 unchanged
1. American Financials CDS - QE3 lifts all boats.
Tightened the most WoW: MS, RDN, GS
Tightened the least WoW: COF, MBI, CB
Tightened the most WoW: BAC, GS, MS
Tightened the least MoM: COF, MBI, JPM
2. European Financials CDS - French, German, Italian, Spanish, and Greek bank swaps all traded lower last week. Spanish banks were notably improved last week, with some reference entities seeing swaps decline by more than 20%.
3. Asian Financial CDS - The global enthusiasm made it all the way to Asia, where Japanese, Chinese and Indian banks all saw default swaps tighten.
4. Sovereign CDS – Sovereign Swaps tightened around the globe last week. As the table below shows, the market thinks the ECB and Fed have driven global risk to the lowest levels this year.
5. High Yield (YTM) Monitor – High Yield rates fell 36 bps last week, ending the week at 6.51% versus 6.86% the prior week.
6. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 12.3 points last week, ending at 1728.
7. TED Spread – The TED spread fell 2 bps last week, ending the week at 28.6 bps this week versus last week’s print of 30.4 bps.
8. Journal of Commerce Commodity Price Index – The JOC index rose 4.3 points, ending the week at 5.34 versus 1.0 the prior week.
9. Euribor-OIS spread – The Euribor-OIS spread tightened by 1 bps to 17 bps. We're not sure how much lower this series can go from here. 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 16 bps, ending the week at 136 bps versus 152 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 2.6% last week, or 89 yuan/ton, to 3477 yuan/ton. In the last four months, Chinese construction steel prices have fallen ~16%. The trend in this series reflects 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 widened to 161 bps, 20 bps wider than a week ago.
14. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 0.6% upside to TRADE resistance and 3.2% 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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