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European Banking Monitor: Bank and Sovereign Swaps Diverge

Takeaway: EU bank swaps tightened while the correspondent sovereign swaps widened. Europe rumbles as indecision on bailouts remains.

Below are key European banking risk monitors, which are included as part of Josh Steiner and the Financial team's "Monday Morning Risk Monitor".  If you'd like to receive the work of the Financials team or request a trial please email .

 

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. 

  

*  Euribor-OIS widened nominally by 1 bp, while the TED spread widened by 2 bps. 

 

On OMTs Reporting: The ECB has stated that Aggregate Outright Monetary Transaction holdings and their market values will be published on a weekly basis and the average duration of Outright Monetary Transaction holdings and the breakdown by country will take place on a monthly basis. There is no indication that the OMTs has been initiated to date.

 

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If you’d like to discuss recent developments in Europe, from the political to financial to social, please let me know and we can set up a call.

 

Matthew Hedrick

Senior Analyst

 

(o)

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European Financials CDS Monitor – 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%). 

 

European Banking Monitor: Bank and Sovereign Swaps Diverge - 55. banks

 

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. 

 

European Banking Monitor: Bank and Sovereign Swaps Diverge - 55. euribor

 

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.  

 

European Banking Monitor: Bank and Sovereign Swaps Diverge - 55. facility


ENERGY: Playing It Safe

Right now, the safety trade is a winner for those who want to trade in and around energy. With the Energy Select Sector SPDR ETF (XLE) trailing the S&P 500 (SPY) by 9.7% year-to-date, the safety trade has outperformed. The best performing factors over the last three months have been low beta, large cap, high multiple (EV/EBITDA) stocks. The trend will likely continue with the strengthening US dollar - especially if Romney wins - putting pressure on oil.

 

ENERGY: Playing It Safe - 1 normal


The Political Machine

Client Talking Points

The Political Machine

With the election taking place tomorrow, the candidates are pulling out all the stops and sparing no expense trying to appeal to independent and undecided voters today. It appears that Mitt Romney has taken the lead by an ever-so-slight margin, but really, this election is too close to call. It’s important to remember that the outcome of this election will weigh strongly on the markets. Romney will be US Dollar bullish and thus bearish on commodities. He’s also said he’ll get rid of Bernanke. If Obama wins, Bernanke is likely to keep his job and thus, we’ll have more of the same quantitative shenanigans and low interest rates for the next four years.

Focus On The Dollar

So with Romney ticking ahead, it makes sense that the US Dollar Index was up +0.65% last week. The index has had one down week over the last seven and is breaking out from an immediate-term TRADE perspective. Dollar up, commodities down. Remember that if you get the dollar right, you tend to get a lot of other things right. Be sure to watch the outcome of the election tomorrow because it’ll definitely affect your trading on Wednesday.

Asset Allocation

CASH 55% US EQUITIES 6%
INTL EQUITIES 0% COMMODITIES 0%
FIXED INCOME 24% INTL CURRENCIES 15%

Top Long Ideas

Company Ticker Sector Duration
TCB

After a long downward slide, TCB has finally turned the corner. The margin has stabilized after the balance sheet restructuring. Loans are growing thanks to the equipment finance business. Non-interest income is more likely to go up than down going forward, a reversal from the past 18 months. Credit quality has a tailwind from a distressed housing recovery in TCB’s core markets: Minneapolis, Detroit and Chicago. On top of this, the CEO, Bill Cooper, is one of the oldest regional bank CEOs, which raises the probability that the bank will be sold. Expectations are bombed out at this point, so we think it’s time to move from bearish to bullish on TCB.

PCAR

Emissions regulations in the US focusing on greenhouse gases should end the disruptive pre-buy cycle and allow PCAR to improve margins. Improved capacity utilization, truck fleet aging, and less volatile used truck prices all should support higher long-run profitability. In the near-term, Paccar may benefit from engine certification issues at Navistar, allowing it to gain market share. Longer-term, Paccar enjos a strong position in a structurally advantaged industry and an attractive valuation.

HCA

While political and reimbursement risk will remain near-term concerns, on the fundamental side we continue to expect accelerating outpatient growth alongside further strength in pricing as acuity improves thru 1Q13. Flu trends may provide an incremental benefit on the quarter and our expectation for a birth recovery should support patient surgery growth over the intermediate term. Supply costs should remain a source of topline & earnings upside going forward.

Three for the Road

TWEET OF THE DAY

“‘During a campaign the air is full of speeches - and vice versa.’ ~ Author Unknown” -@jackstone104

QUOTE OF THE DAY

“Nothing is as simple as we hope it will be.” -Jim Horning

STAT OF THE DAY

Mitt Romney takes the lead on Rasmussen, 49-48%, on the day before the election.


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MONDAY MORNING RISK MONITOR: SANDY HAS LITTLE EFFECT ON BANK SWAPS

Takeaway: EU bank swaps positively diverged from EU sovereigns this past week. Meanwhile, measures of counterparty default risk rose slightly.

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

 

MONDAY MORNING RISK MONITOR: SANDY HAS LITTLE EFFECT ON BANK SWAPS - Summary

 

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

MONDAY MORNING RISK MONITOR: SANDY HAS LITTLE EFFECT ON BANK SWAPS - American CDS

 

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%). 

 

MONDAY MORNING RISK MONITOR: SANDY HAS LITTLE EFFECT ON BANK SWAPS - European  CDS

 

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.

 

MONDAY MORNING RISK MONITOR: SANDY HAS LITTLE EFFECT ON BANK SWAPS - 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.

 

MONDAY MORNING RISK MONITOR: SANDY HAS LITTLE EFFECT ON BANK SWAPS - Sov Table

 

MONDAY MORNING RISK MONITOR: SANDY HAS LITTLE EFFECT ON BANK SWAPS - Sov 1

 

MONDAY MORNING RISK MONITOR: SANDY HAS LITTLE EFFECT ON BANK SWAPS - Sov 2

 

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.

 

MONDAY MORNING RISK MONITOR: SANDY HAS LITTLE EFFECT ON BANK SWAPS - HY

 

6. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 0.3 points last week, ending at 1731.3.

 

MONDAY MORNING RISK MONITOR: SANDY HAS LITTLE EFFECT ON BANK SWAPS - LLI

 

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.

 

MONDAY MORNING RISK MONITOR: SANDY HAS LITTLE EFFECT ON BANK SWAPS - TED

 

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.

 

MONDAY MORNING RISK MONITOR: SANDY HAS LITTLE EFFECT ON BANK SWAPS - JOC

 

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. 

 

MONDAY MORNING RISK MONITOR: SANDY HAS LITTLE EFFECT ON BANK SWAPS - Euribor OIS

 

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.  

 

MONDAY MORNING RISK MONITOR: SANDY HAS LITTLE EFFECT ON BANK SWAPS - ECB

 

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.

 

MONDAY MORNING RISK MONITOR: SANDY HAS LITTLE EFFECT ON BANK SWAPS - MCDX

 

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%.

 

MONDAY MORNING RISK MONITOR: SANDY HAS LITTLE EFFECT ON BANK SWAPS - CHIS

 

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.

 

MONDAY MORNING RISK MONITOR: SANDY HAS LITTLE EFFECT ON BANK SWAPS - 2 10

 

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.

 

MONDAY MORNING RISK MONITOR: SANDY HAS LITTLE EFFECT ON BANK SWAPS - XLF table

 

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. 

 

MONDAY MORNING RISK MONITOR: SANDY HAS LITTLE EFFECT ON BANK SWAPS - Margin Debt

 

Joshua Steiner, CFA

 

Robert Belsky

 



Known Unknowns

“By knowing more about what we don’t know, we may get a few more predictions right.”

-Nate Silver

 

First, my prayers go out to the 2 million Americans who are still without heat this morning on the East Coast. I am part of the 14% without power in Westport, CT. It’s getting colder. If you have the means to help others, please do.

 

Predictions, about the weather, politics, and markets, can get you in trouble; especially if your own money is behind your opinion. I guess the upside to being a partisan political pundit is that you’ll probably be gainfully employed regardless of your predicted outcomes. Right or wrong, someone will probably send you a sticker for effort; particularly if you drove ad revs.

 

From my model’s vantage point, markets have been predicting a closer election than the “expert” polls have been predicting for months. The recent strength in the US Dollar reflects Romney narrowing the gap. Whether or not he can beat Nate Silver’s Obama odds is something neither of us know. After all, that’s the conclusion of Silver’s book (The Signal and The Noise) – don’t trust the polls.

 

Back to the Global Macro Grind

 

Last week, the US Dollar Index was up another +0.65%. It has only had 1 down week in the last 7 and is now breaking out from an immediate-term TRADE duration perspective (after holding its long-term TAIL line of $78.11 support).

 

Nate Silver’s model doesn’t account for this, but those of you who trade markets do. The causality behind a Debauched Dollar has been weak fiscal and monetary policy. Heightening probabilities of Romney not getting crushed raises the probability that Ben Bernanke and Tim Geithner will be employed by Citigroup by 2014. That’s been Dollar Bullish, on the margin.

 

The Known Unknown here is that we don’t know who will win this election, but:

  1. If Obama wins, the US Dollar probably goes down from here
  2. If Romney wins, the US Dollar probably goes up from here

The key word in those Bayesian (conditional probability) statements is probably. Probably doesn’t mean certainly. If neither holds true (what if they tie?) markets could have a tough time digesting what to do next. Like it or not, all the quant machines are trading Correlation Risk, in size.

 

Causality doesn’t always drive correlation; sometimes it does – and big time. For the last 3 months (90 day Correlation Risk model), here are the inverse correlations between the US Dollar Index and the Big Beta driving your portfolio performance:

  1. SP500 = -0.91
  2. Eurostoxx600 Index = -0.97
  3. MSCI World (Equities) = -0.94
  4. CRB Commodities Index = -0.62
  5. Copper = -0.88
  6. Gold = -0.97

Yes, these intermediate-term TREND correlations are surreal. Which makes it likely that if Obama wins, you want to buy the living daylights out of Gold and European Stocks. If Romney wins, you want to respect the likelihood of known knowns (correlations) continuing.

 

Like my not having power for 6 days, legitimate TAIL risk is defined by the unknown unknowns. I didn’t know that was a known unknown until maybe 2 weeks ago. Risk happens fast.

 

Known knowns: for the last month, here’s what Strong Dollar has been doing to Bernanke’s Bubble (Commodities):

  1. Coffee = -15.8% (down -1.9% last week)
  2. Silver = -10.8% (down -3.6% last week)
  3. Copper = -8.4% (down -1.9% last week)
  4. Oil (WTIC) = -7.6% (down -1.6% last week)
  5. Gold = -5.3% (down -1.9% last week)

Sometimes Strong Dollar deflates commodity prices faster than a Debauched Dollar inflates them. That’s been the key risk management lesson of front-running Bernanke’s multiple QE experiments. What goes up, can come down in a hurry.

 

Bernanke has been at the helm of the Federal Reserve for 6 years. He has never raised interest rates. Never is a long time. So, that’s another Known Unknown to consider here that the market doesn’t yet consider a legitimate risk – what it means for the bond market.

 

If Romney wins but:

 

A)     He appoints Glenn Hubbard as his Fed Chief

B)      He appoints John Taylor as his Fed Chief

 

There are 2 very different possible outcomes for the US Bond market overall. Don’t forget, Hubbard is a hard core Keynesian - he could very well make Romney look like Bush, fast. Taylor would raise rates – and could scare the bond market, faster!

 

On the economy, it’s not a secret that I don’t think Obama is a good President. I didn’t think Bush was either. From a US fiscal and monetary policy perspective, those are known knowns in my model. Whether Romney can be any worse is an unknown.

 

My immediate-term risk range for Gold, Oil (Brent), Copper, US Dollar, EUR/USD, UST 10yr Yield, and the SP500 are now $1, $105.17-108.26, $3.44-3.54, $79.86-80.79, $1.27-1.29, 1.67-1.75%, and 1, respectively.

 

Best of luck out there this week,

KM

 

Keith R. McCullough
Chief Executive Officer

 

Known Unknowns - Chart of the Day

 

Known Unknowns - Virtual Portfolio


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