MONDAY MORNING RISK MONITOR: TAKING A SHORT-TERM BREATHER

Takeaway: Rates rising seems to be taking some wind out of the sails for the sector in the short term, but ultimately we think it will be a positive.

Key Takeaways:

 

* High Yield  – High Yield continues to rise, adding another 11 bps last week and closing at 6.46%, up from 6.35%. After troughing briefly on July 22nd at 5.91%, rates have been steadily climbing since. Our firm's view on rates is that they'll continue to grind higher making higher highs and higher lows. Historically, we've seen Financials far more correlated with high yield than they are currently. This is a good sign, as the market is differentiating systemic credit risk from risk of rising rates.

 

* 2-10 Spread – Last week the 2-10 spread widened 21 bps to 249 bps. The 2-10 spread is now at its widest since July 28, 2011. We continue to regard this as a longer-term positive. Historically, movements at the long end of the curve has preceded Fed Funds moves by an average of 8-14 months. While it's certainly possible this time could take longer, the bottom line is that rising short rates will help Financials and wider the curve gets the greater the probability that short rates will move within 12 months.

 

* Chinese Steel – Steel prices in China posted another healthy increase last week, rising a further 1.5%. As China stands out to us as one of the primary global risk externalities capable of derailing the ongoing recovery, we regard the rising price of Chinese steel as an important referendum on the risk posed by a Chinese crisis. 

 

Financial Risk Monitor Summary

 • Short-term(WoW): Positive / 5 of 13 improved / 3 out of 13 worsened / 5 of 13 unchanged

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

 • Long-term(WoW): Positive / 4 of 13 improved / 0 out of 13 worsened / 9 of 13 unchanged

 

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1. U.S. Financial CDS -  Swaps widened broadly for U.S. financials last week, though none of the moves were overly noteworthy.  The largest move among big caps was a 6 bps widening at JPMorgan, where a flurry of negative media/headlines weighed on both equity and credit sentiment in the short-term. The rest of the U.S. financials, however, were largely unchanged with the exception of certain high-beta names like MBIA, MTG & RDN.

 

Tightened the most WoW: AON, PRU, TRV

Widened the most WoW: MBI, JPM, RDN

Tightened the most WoW: MTG, PRU, MS

Widened the most MoM: MBI, AGO, CB

 

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2. European Financial CDS - British, Italian and German banks all widened last week. Sberbank of Russia widened another 6 bps last week to 239 bps. 

 

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3. Asian Financial CDS - Indian banks widened further while Chinese banks tightened. The MoM change in Indian bank swaps is becoming noteworthy. The three major banks of India are now wider by 50-55 bps (~20%) vs one month prior. Japanese financials were largely unchanged WoW.

 

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4. Sovereign CDS – Italy and Spain tightened last week by 6 and 7 bps, respectively, while France and Japan both widened by 2 bps. The rest of the world's major markets were unchanged. 

 

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5. High Yield (YTM) Monitor – High Yield rates rose 11.4 bps last week, ending the week at 6.46% versus 6.35% the prior week.

 

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6. Leveraged Loan Index Monitor – The Leveraged Loan Index fell 2 points last week, ending at 1803.

 

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7. TED Spread Monitor – The TED spread rose 1.1 basis points last week, ending the week at 22.3 bps this week versus last week’s print of 21.2 bps.

 

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8. CRB Commodity Price Index – The CRB index rose 3.9%, ending the week at 292 versus 282 the prior week. As compared with the prior month, commodity prices have increased 0.7% We generally regard changes in commodity prices on the margin as having meaningful consumption implications.

 

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9. Euribor-OIS Spread – The Euribor-OIS spread was unchanged at 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. 

 

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10. Chinese Interbank Rate (Shifon Index) –  The Shifon Index rose 37 basis points last week, ending the week at 3.28% versus last week’s print of 2.91%. The Shifon Index measures banks’ overnight lending rates to one another, a gauge of systemic stress in the Chinese banking system.

 

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11. Markit MCDX Index Monitor – Last week spreads tightened, ending the week at 0 bps versus 96 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 rose 1.5% last week, or 51 yuan/ton, to 3568 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 widened to 249 bps, 21 bps wider 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 1.5% upside to TRADE resistance and 0.2% downside to TRADE support.

 

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Joshua Steiner, CFA

 

Jonathan Casteleyn, CFA, CMT


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