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Takeaway: The XLF continues to rise in the face of broad deterioration in company and sovereign credit swaps. High Yield, meanwhile, blasts off.

Key Takeaways:

High Yield – High Yield rates rose 36.5 bps last week, ending the week at 6.11% versus 5.75% the prior week. This is disconcerting, as we've historically observed fairly tight correlations between U.S. Financials, particularly large caps, and junk yields. The current divergence is an outlier vs. history.

* European Financial CDS - European financials swaps widened considerably, increasing by a median of 18 bps. The U.K., Spanish and Italian banks widened sharply. Italian banks, in particular, were materially wider.

American Financial CDS -  Morgan Stanley was a significant outlier last week, widening by 15 bps to 133 bps. The rest of the large caps were narrowly tighter or slightly wider. It was another week of spreads backing up for mortgage insurers and bond guarantors.

XLF Macro Quantitative Setup – More risk than reward in the short-term. Our Macro team’s quantitative setup in the XLF shows 1.8% upside to TRADE resistance and 3.0% downside to TRADE support.

Financial Risk Monitor Summary

 • Short-term(WoW): Negative / 2 of 13 improved / 6 out of 13 worsened / 5 of 13 unchanged

 • Intermediate-term(WoW): Negative / 3 of 13 improved / 6 out of 13 worsened / 4 of 13 unchanged

 • Long-term(WoW): Positive / 4 of 13 improved / 2 out of 13 worsened / 7 of 13 unchanged

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1. American Financial CDS -  Morgan Stanley was a significant outlier last week, widening by 15 bps to 133 bps. The rest of the large caps were narrowly tighter or slightly wider. It was another week of spreads backing up for mortgage insurers and bond guarantors.

Tightened the most WoW: MET, C, JPM

Widened the most WoW: RDN, TRV, MS

Tightened the most WoW: MBI, AGO, UNM

Widened the most MoM: SLM, AXP, RDN

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2. European Financial CDS - European financials swaps widened considerably, increasing by a median of 18 bps. The U.K., Spanish and Italian banks widened sharply. Italian banks, in particular, were materially wider.

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3. Asian Financial CDS - Indian banks were notably wider last week, with State Bank of India widening by 17 bps and IDB Bank of India wider by 20 bps. Chinese banks were also wider, by an average of 7 bps. In Japan, swaps were mixed, with three advancers, two decliners and one unchanged.

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4. Sovereign CDS – Sovereign swaps were wider around the globe with the sole exception of Germany, which tightened 3 bps to 24 bps., and now trades inside the U.S. by 4 bps. The biggest movers were Portugal, Spain and Ireland at +16, +12 and +8 bps, respectively. 

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5. High Yield (YTM) Monitor – High Yield rates rose 36.5 bps last week, ending the week at 6.11% versus 5.75% the prior week.

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6. Leveraged Loan Index Monitor – The Leveraged Loan Index fell -6.3 points last week, ending at 1793.16.

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7. TED Spread Monitor – The TED spread fell 1.5 basis points last week, ending the week at 23.2 bps this week versus last week’s print of 24.7 bps.

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8. Journal of Commerce Commodity Price Index – The JOC index rose 0.4 points, ending the week at 3.6 versus 3.2 the prior week.

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

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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.  

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11. Markit MCDX Index Monitor – Last week spreads widened 9 bps, ending the week at 75.5 bps versus 66.3 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.

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12. Chinese Steel – Steel prices in China fell 1.4% last week, or 47 yuan/ton, to 3422 yuan/ton. We use Chinese steel rebar prices to gauge Chinese construction activity, and, by extension, the health of the Chinese economy.

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13. 2-10 Spread – Last week the 2-10 spread tightened to 185 bps, -3 bps tighter than a week ago. We track the 2-10 spread as an indicator of bank margin pressure.

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14. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 1.8% upside to TRADE resistance and 3.0% downside to TRADE support.

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Joshua Steiner, CFA

Jonathan Casteleyn, CFA, CMT