* European and American Bank CDS: Bank swaps were tighter in the U.S. and Europe last week on perceived optimism around progress toward averting the Fiscal Cliff. In Europe, however, the news was less positive. Moody's downgraded France (admittedly, a lagging indicator) and there was no concrete agreement on a debt reduction package for Greece after the Eurogroup and IMF meeting. This week, among other things, there is a spate of housing data on tap. Overall, we'd expect the momentum to remain strong in housing, potentially providing a further tailwind to financials.
* Sovereign CDS: Sovereign CDS traded in tandem with bank swaps, broadly declining across all sovereign reference entities. Portugal, Italy, and Spain saw the largest improvements. U.S. swaps were tighter by 1 bp, while Germany tightened by 2 bps. Japan was flat WoW.
* Markit MCDX: The MCDX, our preferred measure of municipal default risk, fell 3 bps last week.
* Chinese Steel Prices: Chinese steel prices fell 47 yuan/ton (or 1.3%) to 3673. Over the last few weeks, steel prices in China have resumed their decline. This comes after a brief rally which peaked on October 10th 2012.
* 2-10 Spread: The 2-10 spread was 8 bps wider than it was a week ago.
*Quantitative Setup: Our Macro team’s quantitative setup in the XLF shows 0.6% upside to TRADE resistance and 1.0% downside to TRADE support.
Financial Risk Monitor Summary
• Short-term(WoW): Positive / 6 of 12 improved / 1 out of 12 worsened / 6 of 12 unchanged
• Intermediate-term(WoW): Negative / 2 of 12 improved / 4 out of 12 worsened / 7 of 12 unchanged
• Long-term(WoW): Positive / 6 of 12 improved / 3 out of 12 worsened / 4 of 12 unchanged
1. American Financial CDS – Last week saw significant improvement in large cap U.S. financials. MS and GS were tighter by 19 and 15 bps, respectively, while BAC and C tightened by 11 and 10 bps. JPM and WFC were also modestly tighter. Overall, 25 of 26 domestic financial institutions tightened last week (AGO was the lone exception, widening by 14 bps).
Tightened the most WoW: MBI, MS, GS
Widened the most/ tightened the least WoW: AGO, ACE, ALL
Tightened the most WoW: JPM, GNW, C
Widened the most MoM: CB, RDN, AIG
2. European Financial CDS – 34 out of 37 financial reference entities in Europe tightened last week, with most of the financial system mirroring what was seen at the sovereign level. French, Spanish, Italian and British banks saw the sharpest WoW improvement.
3. Asian Financial CDS – Bank swaps in Asia were mostly tighter, falling for 10 out of 12 reference entities. Chinese and Indian swaps saw broad improvement while Japanese swaps were mixed, but mostly improved. In Japan, 4 out of 6 reference entities tightened.
4. Sovereign CDS – European sovereign swaps tightened across the board last week with large improvements seen in Italy, Spain and Portugal. Portugal saw the largest week-over-week decline as its sovereign swaps tightened -117 bps to 524 bps. Meanwhile, Italy and Spain saw their swaps tighten by 44 and 33 bps, respectively.
5. High Yield (YTM) Monitor – High Yield rates fell 22 bps last week, ending the week at 6.81% versus 7.03% the prior week. Data was only available for this series through Wednesday (11/21)
6. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 2.5 points last week, ending at 1724.
7. TED Spread Monitor – The TED spread fell 1 basis point last week, ending the week at 22.3 bps this week versus last week’s print of 23.3 bps.
8. Journal of Commerce Commodity Price Index – The JOC index rose 0.1 points, ending the week at -1.8 versus -1.9 the prior week. Data was only available for this series through Wednesday (11/21)
9. Euribor-OIS spread – Euribor-OIS spread widened by less than 1 bps to 12.5 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 3 bps, ending the week at 130 bps versus 133 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 1.3% last week, or 47 yuan/ton, to 3673 yuan/ton. Since their recent highs on Oct 10, Chinese construction steel prices have fallen ~4%. 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 widened 8 bps to 142 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 0.6% upside to TRADE resistance and 1.0% 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