MONDAY MORNING RISK MONITOR: THE GREAT MODERATION

Takeaway: It's important sometimes to take a step back and see the forest for the trees. Rising capital = falling systemic risk = upside.

Risk Monitor / Key Takeaways:

Financials remain full speed ahead. Rising rates, widening spreads, credit tailwinds, excess capital and falling global systemic risk profiles are all encouraging investors to take greater advantage of still attractive valuations across the Financials sector. 

* U.S. Financial CDS -  Overall, swaps tightened for 25 out of 27 domestic financial institutions. Risk perception within the US banking space continues to dwindle as we're now well into our 8th consecutive quarter of averaging sub-20 VIX. This is not by chance. It's our contention that the higher capital levels across the US banking system are creating a stronger, more stable risk environment for both for the country and the banking system. Moreover, a similar path in Europe is adding to the stability on a global scale.

* Asian Financial CDS - Indian banks again widen out. Two out of three Indian banks were notably wider last week (+33-35 bps). On a month-over-month basis, India's banks look worrisome with increases ranging from 40-78 bps. Elsewhere in Asia, however, there's less cause for concern. China's banks were mixed, but generally tighter. Across Japan there was mostly tightening though with a few unchanged. 

 

Financial Risk Monitor Summary

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

 • Intermediate-term(WoW): Positive / 9 of 13 improved / 0 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

MONDAY MORNING RISK MONITOR: THE GREAT MODERATION - 15

1. U.S. Financial CDS -  Overall, swaps tightened for 25 out of 27 domestic financial institutions. Risk perception within the US banking space continues to dwindle as we're now well into our 8th consecutive quarter of averaging sub-20 VIX. This is not by chance. It's our contention that the higher capital levels across the US banking system are creating a stronger, more stable risk environment for both for the country and the banking system. Moreover, a similar path in Europe is adding to the stability on a global scale.

Tightened the most WoW: MBI, UNM, C

Widened the most/ tightened the least WoW: XL, AON, COF

Tightened the most WoW: MBI, AGO, JPM

Widened the most/ tightened the least MoM: XL, TRV, MMC

MONDAY MORNING RISK MONITOR: THE GREAT MODERATION - 1

2. European Financial CDS - Swaps were almost universally tighter across European Financials last week with the sole exception of Greece, where swaps rose across the board. While the most recent week of tightening was somewhat modest, the past month of change has been remarkable. On average, European Financials have tightened up by 46 bps or roughly 21%. #EuroBulls

MONDAY MORNING RISK MONITOR: THE GREAT MODERATION - 2

3. Asian Financial CDS - Indian banks again widen out. Two out of three Indian banks were notably wider last week (+33-35 bps). On a month-over-month basis, India's banks look worrisome with increases ranging from 40-78 bps. Elsewhere in Asia, however, there's less cause for concern. China's banks were mixed, but generally tighter. Across Japan there was mostly tightening though with a few unchanged. 

MONDAY MORNING RISK MONITOR: THE GREAT MODERATION - 17

4. Sovereign CDS – Sovereign swaps were mixed last week with notable improvements coming from Europe while the ROW was modestly wider. Portugal and Italy tightened by 8 and 9 bps, respectively. This trend of ongoing tightening among the PIIGS countries is reflective of our 4Q13 macro theme #EuroBulls. On a month-over-month basis, the only country in our monitor not to show improvement is the US.

MONDAY MORNING RISK MONITOR: THE GREAT MODERATION - 18

MONDAY MORNING RISK MONITOR: THE GREAT MODERATION - 3

MONDAY MORNING RISK MONITOR: THE GREAT MODERATION - 4

5. High Yield (YTM) Monitor – High Yield rates fell 6.3 bps last week, ending the week at 5.94% versus 6.00% the prior week.

MONDAY MORNING RISK MONITOR: THE GREAT MODERATION - 5

6. Leveraged Loan Index Monitor – The Leveraged Loan Index was unchanged last week at 1829.

MONDAY MORNING RISK MONITOR: THE GREAT MODERATION - 6

7. TED Spread Monitor – The TED spread rose 1.8 basis points last week, ending the week at 18.1 bps this week versus last week’s print of 16.3 bps.

MONDAY MORNING RISK MONITOR: THE GREAT MODERATION - 7

8. CRB Commodity Price Index – The CRB index rose 0.6%, ending the week at 275 versus 273 the prior week. As compared with the prior month, commodity prices have decreased -1.0% We generally regard changes in commodity prices on the margin as having meaningful consumption implications.

MONDAY MORNING RISK MONITOR: THE GREAT MODERATION - 8

9. Euribor-OIS Spread – The Euribor-OIS spread widened by 2 bps to 11 bps. As the chart below shows, however, the increase put the measure back in-line with its past month average and is not an indication of rising risk in Europe's banking system. 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. 

MONDAY MORNING RISK MONITOR: THE GREAT MODERATION - 9

10. Chinese Interbank Rate (Shifon Index) –  The Shifon Index fell 15 basis points last week, ending the week at 3.75% versus last week’s print of 3.90%. The Shifon Index measures banks’ overnight lending rates to one another, a gauge of systemic stress in the Chinese banking system.

MONDAY MORNING RISK MONITOR: THE GREAT MODERATION - 10

11. Markit MCDX Index Monitor – Last week spreads tightened 3 bps, ending the week at 81 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.

MONDAY MORNING RISK MONITOR: THE GREAT MODERATION - 11

12. Chinese Steel – Steel prices in China rose 0.1% last week, or 5 yuan/ton, to 3,537 yuan/ton. We use Chinese steel rebar prices to gauge Chinese construction activity, and, by extension, the health of the Chinese economy.

MONDAY MORNING RISK MONITOR: THE GREAT MODERATION - 12

13. 2-10 Spread – Last week the 2-10 spread was unchanged at 246 bps, but remains 21 bps wider month-over-month. We track the 2-10 spread as an indicator of bank margin pressure.

MONDAY MORNING RISK MONITOR: THE GREAT MODERATION - 13

14. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 1.6% upside to TRADE resistance and 1.7% downside to TRADE support.

MONDAY MORNING RISK MONITOR: THE GREAT MODERATION - 14

Joshua Steiner, CFA

Jonathan Casteleyn, CFA, CMT