*European Bank CDS: The Eurozone officially moved into recession last week. Preliminary Q3 GDP contracted by 0.1% QoQ following a 0.2% contraction in Q2. In response, EU bank swaps widened WoW on concern around deteriorating fundamentals in Europe. Despite Draghi's pledge to do "Whatever It Takes", it seems that risk is creeping back into the markets. Along with swaps widening at the bank and sovereign levels, both Euribor-OIS and the TED spread have stopped their march downward and are now slowly pushing higher. For reference, This is the third consecutive week that the Euribor-OIS has risen WoW.
* Sovereign CDS: Sovereign swaps followed (or led?) bank swaps wider in Europe last week for 4 out of the 6 EU sovereign reference entities. The notable exceptions were Germany and Ireland, where swaps tightened nominally. French sovereign (and bank) swaps were noticeably wider WoW.
* Rates on High Yield corporate debt in the U.S. rose 26 bps week-over-week to 7.03% vs 6.77% in the prior week. This is the fourth consecutive week that rates have moved higher. Rates are now 50 bps higher than where they stood a month ago.
* Our Macro team’s Quantitative Setup in the XLF shows that it is broken from an intermediate term TREND duration. On a short-term TRADE basis there is 3.5% upside to TRADE resistance and 3.1% downside to TRADE support.
Financial Risk Monitor Summary
• Short-term(WoW): Negative / 1 of 12 improved / 5 out of 12 worsened / 7 of 12 unchanged
• Intermediate-term(WoW): Negative / 2 of 12 improved / 6 out of 12 worsened / 5 of 12 unchanged
• Long-term(WoW): Positive / 5 of 12 improved / 4 out of 12 worsened / 4 of 12 unchanged
1. U.S. Financial CDS – U.S. large cap financials were more or less flat WoW, but remain significantly wider MoM. MS, GS and BAC are wider by 32 bps, 28 bps and 22 bps, respectively. Overall, default swaps widened for 21 out of 27 U.S. financials. MBIA widened by 415 bps WoW on the news that BofA was buying MBIA debt in an effort to block the separation of the the muni business from the structured finance business.
Widened the most WoW: MBI, AIG, LNC
Tightened the most WoW: BAC, C, MTG
Widened the most MoM: MBI, AIG, CB
Widened the least/ tightened the most WoW: GNW, UNM, MTG
2. European Financial CDS – French banks continue to widen on the news that Europe is officially back in recession. BNP and Credit Agricole were wider WoW, bringing their MoM changes to +44 and +35 bps. Soc Gen was flat WoW, but is up a similar +42 bps MoM. Italian banks are also notably wider MoM.
3. Asian Financial CDS – Japanese brokers continue to tighten. Daiwa, Matsui and Nomura tightened by 14, 10 and 6 bps, respectively bringing their MoM change to -32 bps, -47 bps and -63 bps. The Japanese banks have been stable over the same time period. Chinese banks were slightly wider WoW, but are more or less flat MoM. Indian banks also widened this past week.
Chinese and Indian banks continued to widen across the board week-over-week. In contrast, Japanese banks were mostly tighter with swaps falling for 4 out of 6 Japanese reference entities.
4. Sovereign CDS – Portuguese sovereign default swaps widened by 46 bps WoW to 641 bps, an increase of 8%. However, outside of Portugal it was a fairly benign week for sovereign swaps. Italy was flat. Spain widened by 8 bps. France widened by 7 bps. Ireland, Japan, the U.S. and Germany all moved by 3 bps or less.
5. High Yield (YTM) Monitor – High Yield rates rose 26.1 bps last week, ending the week at 7.03% versus 6.77% the prior week.
6. Leveraged Loan Index Monitor – The Leveraged Loan Index fell 11.6 points to 1722 points last week. Leveraged loans are off ~1% in the past month.
7. TED Spread Monitor – The TED spread rose 1.7 bps points last week, ending the week at 23.3 bps this week versus last week’s print of 21.6 bps. This gauge of U.S. interbank risk has risen roughly 3 bps in the last month.
8. Journal of Commerce Commodity Price Index – The JOC index rose 1.5 points, ending the week at -2.08 versus -3.6 the prior week.
9. Euribor-OIS spread – The Euribor-OIS spread widened by less than a basis point to 12 bps. This series has been moving essentially sideways for the last month. 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 – In a positive sign for the stability of the EU Banking System, the ECB Liquidity Deposits continued to decline in the latest week. 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 by 1.4 bps, ending the week at 133 bps versus 134 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 0.5% last week, or 18 yuan/ton, to 3720 yuan/ton. Since their recent highs on Oct 10, Chinese construction steel prices have fallen ~3%. The broader downward trend, which started August of last year, remains intact and is a sign of ongoing weakness in the Chinese construction market.. We use Chinese steel rebar prices to gauge Chinese construction activity, and, by extension, the health of the Chinese economy.
13. 2-10 Spread – The 2-10 spread tightened 1 bp to 134 bps. 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 that it is broken from an intermediate term TREND duration. On a short-term TRADE basis there is 3.5% upside to TRADE resistance and 3.1% 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