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European Banking Monitor: Mixed

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 .

 

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European Financial CDS - Though unremarkable, European financial swaps were broadly wider last week with a median increase of 8 bps. Barclays (+13 bps), Deutsche Bank (+10 bps) and UBS (+8 bps) showed the largest deterioration, while DNB of Norway, Investor AB of Sweden and Danske Bank of Denmark were all tighter.

 

European Banking Monitor: Mixed - tt. banks

 

Sovereign CDS – Sovereign swaps were mixed last week with Italy and Spain widening by 15 and 8 bps, respectively, while Germany and France tightened by 2 and 4 bps. Meanwhile, Japan widened 7 bps to 72 bps. The U.S. was unchanged at 30 bps, one basis point narrower than Germany.

 

European Banking Monitor: Mixed - tt. sov 1

 

European Banking Monitor: Mixed - tt. sov 2

 

European Banking Monitor: Mixed - tt. sov 3

 

Euribor-OIS Spread – The Euribor-OIS spread tightened by 1 bps to 13 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: Mixed - tt. euribor

 

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.  

 

European Banking Monitor: Mixed - tt. facility

 


What’s Up With the Swissy?

TRADE Call (3 weeks or less): The CHF remains overvalued versus the USD and EUR; expectations that the SNB could shift the floor in the EUR/CHF or cut rates to negative may burn the CHF lower. (etf: FXF)

 

TREND Call (3 months or more): We’re bullish on the USD versus the CHF as our #StrongDollar remains intact. However, the CHF could strengthen against major currencies if it moves back to “safe-haven” status, especially should we experience another round of sovereign or banking risk scares out of the Eurozone, and/or if the SNB does not cut below 0%.

 

The Swiss Nation Bank (SNB) meets next on June 20th to discuss its interest rate policy. There’s speculation based on comments from the SNB’s head Thomas Jordan last week that it could implement negative interest rates and shift the floor in the EUR/CHF. [Last Wednesday the EUR/CHF hit 1.2614, the weakest level for the franc since May 2011].  We believe over the immediate term TRADE there’s more weakness in the EUR/CHF and USD/CHF. Beyond the potential policy moves by the SNB, we’ve seen investors pulling assets from the “safe-haven” trade and we remain grounded in our #StrongDollar call.

 

As we show in the first chart below, beginning in September 2011 (following the CHF appreciating to an all-time high in August) the SNB bought foreign reserves to maintain a floor in the EUR/CHF at 1.20 francs. Since September 2011 the SNB has increased its FX reserves by +125%, and we have reason to believe that the SNB wants to get involved in the global currency war. Both a cut to the 3M target interest rate (currently at 0%) into negative territory, and continued FX buying and/or an adjustment in the EUR/CHF higher could burn the CHF lower versus the EUR and USD, at least over the near term.  

 

What’s Up With the Swissy? - YY. FX RESERVES

 

What’s Up With the Swissy? - YY. CHF LT

 

 

Policy Challenges


In many ways the SNB is in a tough spot to manage the economy. These challenges include:

  • Swings in the currency to and from safe-haven status
  • Steady deflation
  • Low interest rates

The amount of FX buying from the SNB shows just how terrified it is of a strong currency. The worry here is two-fold -- that a strong currency 1.) will cripple export demand and 2.) force domestic companies to lower prices to ward off cheaper imports.

 

With about 60% of exports destined for the EU, it’s interesting to note that there’s a relatively weak relationship between the overall price of the currency and export demand. Below we show that the correlation between the CHF/EUR and Swiss Exports is +0.41. We think some of the weakness in this correlation can be explained by its basket of export goods, with a heavy mix of pharmaceutical and luxury exports, which command pricing power.

 

So while rhetorically there might be great emphasis placed on the threat of a strong CHF on exports, we do not think it holds up. 

 

What’s Up With the Swissy? - YY. EXPORTS

 

On deflation, Switzerland has been hit by a steady level of deflation since late 2011, with CPI falling for 19th straight months (currently at 0.40% Y/Y). We believe that while Switzerland has benefitted from falling energy prices from a stronger USD, the Bank wrestles with its policy to promote inflation. It fears that under an environment of steady deflation consumers will put off purchasing, assuming prices will go lower in the future.

 

So, while the Bank is hardly worried about stoking inflation with a rate cut, it’s aware of the policy risks around cutting from 0%:

  • further taxing savers
  • stoking a mortgage and housing bubble
  • chasing away safe-haven assets
  • no ability to guarantee that negative rates will incentivize banks to increase lending

While we’ve yet to see signs of a dangerous expansion in the mortgage and housing market (the SNB cut to 0% in August 2011), this threat remains on the minds of policy makers. We’re also seeing investors park less of their assets in Francs or Franc-denominated assets as the risk climate in the Eurozone improves.

 

One big question mark that remains is the extent to which banks, especially if the SNB cuts to negative rates, increases their lending to seeks a better return on money.  

 

What’s Up With the Swissy? - YY. CPI

 

 

Broader Fundamentals Appear Strong, Relatively


Below is a snapshot of Swiss GDP. Our call-out here is that with GDP low to depressed across much of the region, we think Switzerland’s relative outperformance will continue to anchor a market of strong investment despite low interest rates.  A weaker CHF versus its trading partners on the margin will also remain a positive.

 

Swiss GDP is forecast to rise +1.3% this year versus -0.50% in the Eurozone. With a Swiss budget surplus of +0.3% of GDP in 2012 and debt of 53% of GDP last year, its fiscal house remains in order and could quickly transition back to its safe-haven status should we get another round of sovereign or banking risk scares out of the Eurozone.

 

What’s Up With the Swissy? - YY. GDP

 

Below is a graphic illustrating our levels on USD/CHF via the etf FXF. We outline the intermediate term TREND line that the FXF violated. We view this as a bearish signal and expect weakness into the SNB’s June 20th meeting. Should the bank act, either in cutting rates, and/or adjusting the floor, or setting future expectations for either, we’d expect further weakness. 

 

What’s Up With the Swissy? - XX. FXF

 

The Swiss Market Index (SMI) is up 20.5% YTD, leading the pack as the best performing European index YTD. The SMI is up 4.6% MTD and as we outline in the chart below (via the etf EWL), is in a bullish formation. 

 

What’s Up With the Swissy? - XX. EWL

 

 

Matthew Hedrick

Senior Analyst

 

 

 

 


HEARD ON THE AM CALL: GOT YIELD?

Takeaway: Our Central Planner in Chief is not bullish enough on growth.

(Excerpt from this morning's Hedgeye conference call)

 

Just to show you how horrendous being long no-growth “yield” is performing, here’s the score:

 

  1. Utilities (XLU) are down -6.3% in May
  2. Financials (XLF) are leading the S&P 500 up +5.5% in May

That is a huge divergence.

 

So, why are utilities getting crushed, while financials (and US Treasury Yields) are ripping higher? Simple. Because one likes growth, and the other doesn’t like Bernanke.

 

The market is now – explicitly and implicitly – betting against the Chairman of the Federal Reserve. The bottom line here? Ben Bernanke is not bullish enough on growth.

 

#GrowthAccelerating

 

HEARD ON THE AM CALL: GOT YIELD? - xlf.xlu


Hedgeye Statistics

The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

  • LONG SIGNALS 80.28%
  • SHORT SIGNALS 78.51%

TUESDAY MORNING RISK MONITOR: TEMPERING ENTHUSIASM

Takeaway: The risk monitor has turned somewhat bearish on a short term basis. We're keeping an eye on high yield for indications of a change.

Key Takeaways:

 

Overall, our gauges of risk show broad deterioration on an immediate term basis, though remain bullish on an intermediate and long term basis. The recent back-up in High Yield, Municipal Credit and widening in U.S. Financial swaps are all an inflection from the YTD trends. 

 

* High Yield (YTM) Monitor – High Yield rates rose 16.0 bps last week, ending the week at 5.47% versus 5.31% the prior week.

 

* Sovereign CDS – Sovereign swaps were mixed last week with Italy and Spain widening by 15 and 8 bps, respectively, while Germany and France tightened by 2 and 4 bps. Meanwhile, Japan widened 7 bps to 72 bps. The U.S. was unchanged at 30 bps, one basis point narrower than Germany.

 

* U.S. Financial CDS -  Swaps widened for 22 out of 27 domestic financial institutions. The large cap financials were all wider, by an average of 5 bps. Credit card companies AXP and COF widened by a comparable 7 bps and 6 bps, respectively. Meanwhile, mortgage insurers MTG and RDN widened on the week by a modest 12 and 7 bps, respectively, but that marks the second week in a row of no improvement for one of the most levered plays to the housing recovery.

 

Financial Risk Monitor Summary

 • Short-term(WoW): Negative / 0 of 13 improved / 6 out of 13 worsened / 7 of 13 unchanged

 • Intermediate-term(WoW): Positive / 8 of 13 improved / 1 out of 13 worsened / 4 of 13 unchanged

 • Long-term(WoW): Positive / 4 of 13 improved / 1 out of 13 worsened / 8 of 13 unchanged

 

TUESDAY MORNING RISK MONITOR: TEMPERING ENTHUSIASM - 15

 

1. U.S. Financial CDS -  Swaps widened for 22 out of 27 domestic financial institutions. The large cap financials were all wider, by an average of 5 bps. Credit card companies AXP and COF widened by a comparable 7 bps and 6 bps, respectively. Meanwhile, mortgage insurers MTG and RDN widened on the week by a modest 12 and 7 bps, respectively, but that marks the second week in a row of no improvement for one of the most levered plays to the housing recovery.

 

Tightened the most WoW: MMC, AGO, MBI

Widened the most WoW: AXP, ALL, COF

Tightened the most WoW: MBI, AGO, RDN

Tightened the least MoM: MET, ACE, TRV

 

TUESDAY MORNING RISK MONITOR: TEMPERING ENTHUSIASM - 1

 

2. European Financial CDS - Though unremarkable, European financial swaps were broadly wider last week with a median increase of 8 bps. Barclays (+13 bps), Deutsche Bank (+10 bps) and UBS (+8 bps) showed the largest deterioration, while DNB of Norway, Investor AB of Sweden and Danske Bank of Denmark were all tighter.

 

TUESDAY MORNING RISK MONITOR: TEMPERING ENTHUSIASM - 2

 

3. Asian Financial CDS - Asian financial swaps widened across the board last week, increasing by an average 6 bps. Increases were controlled, with all but two falling in the single digit basis point range. 

 

TUESDAY MORNING RISK MONITOR: TEMPERING ENTHUSIASM - 17

 

4. Sovereign CDS – Sovereign swaps were mixed last week with Italy and Spain widening by 15 and 8 bps, respectively, while Germany and France tightened by 2 and 4 bps. Meanwhile, Japan widened 7 bps to 72 bps. The U.S. was unchanged at 30 bps, one basis point narrower than Germany.

 

TUESDAY MORNING RISK MONITOR: TEMPERING ENTHUSIASM - 18

 

TUESDAY MORNING RISK MONITOR: TEMPERING ENTHUSIASM - 3

 

TUESDAY MORNING RISK MONITOR: TEMPERING ENTHUSIASM - 4

 

5. High Yield (YTM) Monitor – High Yield rates rose 16.0 bps last week, ending the week at 5.47% versus 5.31% the prior week.

 

TUESDAY MORNING RISK MONITOR: TEMPERING ENTHUSIASM - 5

 

6. Leveraged Loan Index Monitor – The Leveraged Loan Index fell -1.1 points last week, ending at 1804.6.

 

TUESDAY MORNING RISK MONITOR: TEMPERING ENTHUSIASM - 6

 

7. TED Spread Monitor – The TED spread fell 0.6 basis points last week, ending the week at 23.5 bps this week versus last week’s print of 24.1 bps.

 

TUESDAY MORNING RISK MONITOR: TEMPERING ENTHUSIASM - 7

 

8. Journal of Commerce Commodity Price Index – The JOC index rose 0.6 points, ending the week at 3.82 versus 3.2 the prior week.

 

TUESDAY MORNING RISK MONITOR: TEMPERING ENTHUSIASM - 8

 

9. Euribor-OIS Spread – The Euribor-OIS spread tightened by 1 bps to 13 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. 

 

TUESDAY MORNING RISK MONITOR: TEMPERING ENTHUSIASM - 9

 

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.  

 

TUESDAY MORNING RISK MONITOR: TEMPERING ENTHUSIASM - 10

 

11. Markit MCDX Index Monitor – Last week spreads widened 4 bps, ending the week at 61.7 bps versus 57.7 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. 

 

TUESDAY MORNING RISK MONITOR: TEMPERING ENTHUSIASM - 11

 

12. Chinese Steel – Steel prices in China fell 0.8% last week, or 27 yuan/ton, to 3,536 yuan/ton. We use Chinese steel rebar prices to gauge Chinese construction activity, and, by extension, the health of the Chinese economy.

 

TUESDAY MORNING RISK MONITOR: TEMPERING ENTHUSIASM - 12

 

13. 2-10 Spread – Last week the 2-10 spread tightened to 169 bps, -4 bps tighter than a week ago. We track the 2-10 spread as an indicator of bank margin pressure.

 

TUESDAY MORNING RISK MONITOR: TEMPERING ENTHUSIASM - 13

 

14. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 2.3% upside to TRADE resistance and 2.5% downside to TRADE support.

 

TUESDAY MORNING RISK MONITOR: TEMPERING ENTHUSIASM - 14

 

Joshua Steiner, CFA

 

Jonathan Casteleyn, CFA, CMT

 

 


Morning Reads From Our Sector Heads

Takeaway: Here's a look at some articles Hedgeye sector heads are reading this morning.

Keith McCullough - CEO

Li Tells Germany That China Targets 7% Growth for Decade (via Bloomberg)

Sudan's Bashir threatens to cut oil flow from S Sudan (via BBC)

 

Josh Steiner - Financials

U.K. Banks Cut 189,000 With Employment at Nine-Year Low (via Bloomberg)

Larry Summers has an edge in the race to head the Federal Reserve (via FT)

GSE Reform Bill Quietly in Works Under Sen. Corker (via American Banker)

 

Howard Penney - Restaurants

Coffee Overkill Has More Marketers Thinking That It's Time for Tea (via AdvertisingAge)

McDonald's joins forces with 136-year-old pasta firm in Italy (via The Guardian)

 

Daryl Jones - Macro

U.S. Oil Boom Divides OPEC (via WSJ)

East Coasters Drive Down Gasoline Demand (via WSJ)

 

Kevin Kaiser – Energy

Commodities Provide Tailwind (via WSJ)

Bitumen facility blamed for Peace Country health woes (via CBC News)


All About the Dollar

Client Talking Points

YEN

One way to get the US Dollar right is to get the USD/YEN pair right. We made a call to re-short Yens at 101.21 on Friday, as that was immediate-term TRADE resistance; no support to 103.66, then 107.11; Yen down = Weimar Nikkei up too. Bottom line: Getting the USD right remains critical.

DAX

We saw a big move in European Equities this morning, led by the majors (FTSE +1.5% and DAX +1.2%). The immediate-term TRADE line for the DAX that matters to me is 8398, and its back above that now – no resistance to 8546.

UST 10YR

Treasury yields are continuing to track US jobless claims like a glove (pro growth signal with bullish momentum); 2.04% on the 10yr this morning widens the Yield Spread (10s minus 2s) to +179bps wide (new 3 month highs). That is powering the Financials (XLF) higher, up +5.5% for May alone.

Asset Allocation

CASH 36% US EQUITIES 18%
INTL EQUITIES 18% COMMODITIES 0%
FIXED INCOME 0% INTL CURRENCIES 28%

Top Long Ideas

Company Ticker Sector Duration
IGT

Decent earnings visibility, stabilized market share, and aggressive share repurchases should keep a floor on the stock.  Near-term earnings, potentially big orders from Oregon and South Dakota, and news of proliferating gaming domestically could provide near term catalysts for a stock that trades at only 11x EPS.  We believe that multiple is unsustainably low – and management likely agrees given the buyback – for a company with the balance sheet and strong cash flow as IGT.  Given private equity’s interest in WMS (they lost out to SGMS) – a company similar to IGT that unlike IGT generates little free cash – we wouldn’t rule out a privatizing transaction to realize the inherent value in this company.  

WWW

WWW is one of the best managed and most consistent companies in retail. We’re rarely fans of acquisitions, but the recent addition of Sperry, Saucony, Keds and Stride Rite (known as PLG) gives WWW a multi-year platform from which to grow. 

FDX

With FedEx Express margins at a 30+ year low and 4-7 percentage points behind competitors, the opportunity for effective cost reductions appears significant. FedEx Ground is using its structural advantages to take market share from UPS. FDX competes in a highly consolidated industry with rational pricing. Both the Ground and Express divisions could be separately worth more than FDX’s current market value, in our view.

Three for the Road

TWEET OF THE DAY

"Gold has been considering an end to QE for 5 months #study"

@KeithMcCullough

QUOTE OF THE DAY

“A coach is someone who can give correction without causing resentment.” -John Wooden

STAT OF THE DAY

Mass layoffs in the U.S. (cuts involving 50 employees are more) are at the lowest level since June 2007.


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