Key Takeaways
* EU bank swaps tightened while the correspondent sovereign swaps widened. Among the strongest movers week over week were the Italian banks, dropping by an average of 14 bps. European banks, overall, were tighter across the board.
* In the U.S., consumer finance companies, moneycenter banks, and the large brokers saw their swaps tighten, while insurance companies widened in the aftermath of hurricane Sandy.
* The MCDX, our preferred measure of municipal default risk, tightened by 3 bps last week.
* Euribor-OIS widened nominally by 1 bp, while the TED spread widened by 2 bps.
* High yield and leveraged loans, our proxies for risk, were essentially flat week-over-week.
Financial Risk Monitor Summary
• Short-term(WoW): Negative / 2 of 12 improved / 3 out of 12 worsened / 8 of 12 unchanged
• Intermediate-term(WoW): Positive / 8 of 12 improved / 1 out of 12 worsened / 4 of 12 unchanged
• Long-term(WoW): Positive / 7 of 12 improved / 2 out of 12 worsened / 4 of 12 unchanged
1. American Financial CDS – Swaps continued to tighten at US financial companies. The money center banks saw another week of broad-based improvement with Citi swaps compressing a full 10 bps and Morgan Stanley dropping 12 bps. P&C insurers saw swaps widen modestly on the fallout from Hurricane Sandy. Overall, swaps tightened for 18 out of 27 domestic financial institutions.
- Tightened the most WoW: MTG, C, MS
- Widened the most WoW: CB, ALL, TRV
- Tightened the most WoW: MS, PRU, JPM
- Widened the most MoM: CB, AIG, XL
2. European Financial CDS – The Italian, Spanish, French, German and British banks were all tighter last week, an interesting divergence relative to the sovereign swaps, which were generally wider. The largest moves were in Italy's banks, where swaps tightened by an average 14 bps. Overall 30 out of 37 European financial reference entities tightened last week (81%).
3. Asian Financial CDS – Chinese and Indian banks were modestly tighter WoW. Japanese banks were a mixed bag with 3 out of 6 reference entities tightening. Overall, 9 out of 12 swaps tightened in Asia.
4. Sovereign CDS – European Sovereign Swaps widened last week. Portugal, Ireland, and Italy saw the largest increases at 43 bps, 33 bps, and 17 bps, respectively. Meanwhile, Germany, France and Spain also saw swaps widen by 7 bps, 10 bps and 4 bps.
5. High Yield (YTM) Monitor – High Yield rates rose 1 bps last week, ending the week at 6.67% versus 6.66% the prior week.
6. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 0.3 points last week, ending at 1731.3.
7. TED Spread Monitor – The TED spread rose 2 bps last week, ending the week at 22 bps this week versus last week’s print of 19.9 bps.
8. Journal of Commerce Commodity Price Index – The JOC index fell 0.1 point, ending the week at -4.9 versus -4.8 the prior week.
9. Euribor-OIS spread – The Euribor-OIS spread widened by 1 bp to 12 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 amount drawn under this facility continues to decline - a trend that's been in place since the middle of this year. 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 132 bps versus 135 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 0.3% last week, or 13 yuan/ton, to 3,750 yuan/ton. Chinese steel prices are an important indicator as it reflects the activity level in the Chinese construction market, and, by extension, China's economy. After peaking in mid-2011 at 5,000 yuan/ton, prices fell over the following 12 months to less than 3,500 yuan/ton, a decline of 30%. However, in the last few months prices have rebounded to 3,750, an increase of 7%.
13. 2-10 Spread – We track the 2-10 spread as an indicator of bank margin pressure. Last week the 2-10 spread tightened to 143 bps, 2 bps tighter than a week ago.
14. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 1.2% upside to TRADE resistance and 0.3% downside to TRADE support.
Margin Debt - September: +1.12 standard deviations
NYSE Margin debt rose to $315 billion in September from $287 billion in August. 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 September.
Joshua Steiner, CFA
Robert Belsky