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    MARKET EDGES

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Takeaway: We continue to see few, if any, indications of trouble brewing on the risk front.

Risk Monitor / Key Takeaways:

Financials continue their winning ways, rising another 1.3% last week. Based on our interpretation of the risk monitor the setup remains very favorable from an intermediate term trend standpoint. The short-term trade setup is less favorable, though not negative. A few of the callouts include ongoing stability/further tightening in the TED Spread and Euribor-OIS, but further widening in the Shifon Index. Rising rates are also generally a tailwind with the month-over-month change in the 2-10 yield spread now at 14 bps. We provide a brief summary below of some of the notable callouts across the various risk measures we track.

* Sovereign CDS – Portuguese sovereign swaps widened 14 bps last week, but it was the exception. Elsewhere, swaps either tightened or went unchanged. The largest improvements came from the US and Japan, tightening 6 and 4 bps, respectively. 

* Asian Financial CDS - Indian banks widened significantly last week with ICICI wider by 40 bps and the other two major Indian banks wider by 24-25 bps. Chinese banks were mostly unchanged except for Bank of China, where swaps widened by 4 bps. Japan's banks were mixed last week with the largest move coming from Matsui, where swaps widened by 14 bps to 231 bps.

* U.S. Financial CDS -  Large cap US banks were tighter across the board last week with an average improvement of 5 bps. Insurers also posted strong improvement, tightening by an average 8 bps. Overall, swaps tightened for 20 out of 27 domestic financial institutions.

Financial Risk Monitor Summary

 • Short-term(WoW): Positive / 2 of 13 improved / 1 out of 13 worsened / 10 of 13 unchanged

 • Intermediate-term(WoW): Positive / 9 of 13 improved / 1 out of 13 worsened / 3 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 -  Large cap US banks were tighter across the board last week with an average improvement of 5 bps. Insurers also posted strong improvement, tightening by an average 8 bps. Overall, swaps tightened for 20 out of 27 domestic financial institutions.

Tightened the most WoW: MBI, AGO, CB

Widened the most WoW: RDN, MTG, XL

Tightened the most WoW: MBI, AGO, MS

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

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2. European Financial CDS - European banks posted a rare week of widening, but only nominally so. The average change was +2 bps. Spanish and Italian banks showed the largest increases, though those increases were still relatively modest at 10-11 bps. Improvements came from Greek and Belgian banks, where swaps continued to tighten.

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3. Asian Financial CDS - Indian banks widened significantly last week with ICICI wider by 40 bps and the other two major Indian banks wider by 24-25 bps. Chinese banks were mostly unchanged except for Bank of China, where swaps widened by 4 bps. Japan's banks were mixed last week with the largest move coming from Matsui, where swaps widened by 14 bps to 231 bps.

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4. Sovereign CDS – Portuguese sovereign swaps widened 14 bps last week, but it was the exception. Elsewhere, swaps either tightened or went unchanged. The largest improvements came from the US and Japan, tightening 6 and 4 bps, respectively. 

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5. High Yield (YTM) Monitor – High Yield rates rose 1.2 bps last week, ending the week at 6.05% versus 6.04% the prior week.

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6. Leveraged Loan Index Monitor – The Leveraged Loan Index was unchanged last week, ending at 1828.

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7. TED Spread Monitor – The TED spread fell 1.9 basis points last week, ending the week at 16.7 bps this week versus last week’s print of 18.64 bps.

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8. CRB Commodity Price Index – The CRB index rose 0.1%, ending the week at 274 versus 274 the prior week. As compared with the prior month, commodity prices have decreased -4.2% 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 rose 43 basis points last week, ending the week at 4.19% versus last week’s print of 3.76%. 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 -1 bps, ending the week at 85 bps versus 86 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 0.4% last week, or 16 yuan/ton, to 3,543 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 242 bps, 13 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 1.7% downside to TRADE support.

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Joshua Steiner, CFA

Jonathan Casteleyn, CFA, CMT