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Takeaway: Both the US & EU banking systems are leading the charge higher as systemic risk measures remain in check, rates rise and the CRB falls.

Risk Monitor / Key Takeaways:

Friday was a watershed day as rates rose and Financials rallied aggressively, the best performing sector in the market. Not surprisingly, we saw a close resemblance between Friday's performance and the broader performance from early May to early September, i.e. the positively correlated, rate-sensitive Financials that led the charge from May to Sep were back in force on Friday. The Financials are now again bullish across all 3 durations in our quantitative model. We provide a brief summary below of some of the notable callouts across the various risk measures we track.

* 2-10 Spread – Last week the 2-10 spread widened to 230 bps, 6 bps wider than a week ago. 

* Chinese Interbank Rate (Shifon Index) –  The Shifon Index fell 56 basis points last week, ending the week at 3.73% versus last week’s print of 4.289%.

* CRB Commodity Price Index – The CRB index fell -2.0%, ending the week at 274 versus 280 the prior week. As compared with the prior month, commodity prices have decreased -4.5% 

* High Yield (YTM) Monitor – High Yield rates rose 8.2 bps last week, ending the week at 6.03% versus 5.95% the prior week.

* European Financial CDS - Swaps tightened broadly across European Financials last week. #EuroBulls remains alive and well in the banking sector..

Financial Risk Monitor Summary

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

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

 • Long-term(WoW): Positive / 3 of 13 improved / 1 out of 13 worsened / 9 of 13 unchanged

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1. U.S. Financial CDS -  Last week was largely uneventful for US banks and insurers as swaps were decidely mixed and little changed. Overall, swaps widened for 15 out of 27 domestic financial institutions, rising by a median 2 bps (though unch'd on an average basis). 

Tightened the most WoW: WFC, HIG, MBI

Widened the most WoW: CB, ALL, AXP

Tightened the most WoW: MTG, MS, AGO

Widened the most/ tightened the least MoM: GNW, GNW, TRV

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2. European Financial CDS - Swaps tightened broadly across European Financials last week. #EuroBulls remains alive and well in the banking sector as the EU Financials posted a mean and median tightening of 5 and 14 bps, respectively. The biggest improvements came from Greece, Spain, Italy and Portugal. The only negative divergence was again Sberbank of Russia, where swaps widened 7 bps to 219 bps on further commodity deflation.

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3. Asian Financial CDS - Asia was again mixed last week, but generally worse. Indian banks saw swaps at 2 out of 3 rise materially. Japanese banks were generally higher with the exception of Daiwa where swaps tightened 3 bps. Chinese banks were also mixed with two tightening 5 bps and one widening 4 bps.

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4. Sovereign CDS – Sovereign swaps were tighter across the board except in the US, where swaps widened a modestt 1 bp to 31 bps. The biggest improvements came from Portgual (-31 bps) and Spain (-13 bps). 

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5. High Yield (YTM) Monitor – High Yield rates rose 8.2 bps last week, ending the week at 6.03% versus 5.95% the prior week.

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6. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 7.0 points last week, ending at 1828.

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7. TED Spread Monitor – The TED spread fell 1.4 basis points last week, ending the week at 18.6 bps this week versus last week’s print of 19.98 bps.

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8. CRB Commodity Price Index – The CRB index fell -2.0%, ending the week at 274 versus 280 the prior week. As compared with the prior month, commodity prices have decreased -4.5% 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 11 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 fell 56 basis points last week, ending the week at 3.73% versus last week’s print of 4.289%. 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 widened 2 bps, ending the week at 86 bps versus 84 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 1.4% last week, or 49 yuan/ton, to 3559 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 230 bps, 6 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 0.6% upside to TRADE resistance and 1.5% downside to TRADE support.

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Joshua Steiner, CFA

Jonathan Casteleyn, CFA, CMT