Split Signals:
We've been arguing in favor of a defensive posture in Financials for a few weeks now. Our main qualms with the bull case have been rising interbank systemic risk measures, rising commodity prices, which precipitate a slowing of economic growth, and a compressing yield curve. Here's the latest score on those fronts: Euribor-OIS continues to widen, albeit very modestly in the latest print. TED Spread, however, tightened a few basis points in the latest week. Commodity prices continue to rise as reflected in the CRB Index's 3.4% week-over-week increase and the now +7.2% increase on a month-over-month basis. Finally, the 2-10 yield spread was uneventful, tightening 1 bp last week to 242 bps. The notable reversal here vs recent weeks is the now tightening TED Spread, putting it at odds, from a signaling standpoint, with the widening Euribor-OIS. For now, we'll continue to err on the side of caution.
Key Points:
* CRB Commodity Price Index – The CRB index rose 3.4%, ending the week at 302 versus 292 the prior week. As compared with the prior month, commodity prices have increased 7.2% We generally regard changes in commodity prices on the margin as having meaningful consumption implications.
* Euribor-OIS Spread – The Euribor-OIS spread widened by half a basis point to 15.4 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.
* High Yield (YTM) Monitor – High Yield rates fell 9.8 bps last week, ending the week at 5.77% versus 5.86% the prior week.
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 / 6 of 13 improved / 3 out of 13 worsened / 4 of 13 unchanged
• Long-term(WoW): Positive / 5 of 13 improved / 2 out of 13 worsened / 6 of 13 unchanged
1. U.S. Financial CDS - Overall, swaps tightened for 23 out of 27 domestic financial institutions. Interestingly, while the US Financials saw their median CDS tighten by 2 bps, the median stock price change was lower by 20 bps.
Tightened the most WoW: SLM, UNM, MET
Widened the most WoW: CB, ACE, AXP
Tightened the most WoW: MBI, PRU, AGO
Widened the most MoM: CB, C, ACE
2. European Financial CDS - It was a fairly uneventful week for EU bank swaps as the median change was zero basis points. #Steady as she goes.
3. Asian Financial CDS - Asian bank swaps were a mixed bag last week. The biggest improvement came from two of India's banks, ICICI and IDB, though State Bank of India widened. Results were mixed in China and generally, though modestly, tighter in Japan.
4. Sovereign CDS – Sovereign swaps were flat to tighter around the world last week. Italian and Portuguese sovereign swaps tightened by -3.6% (-6 bps to 153 ) and -2.0% (5 bps to 254 bps). Spanish and German swaps were unchanged at 135 and 25 bps, respectively.
5. High Yield (YTM) Monitor – High Yield rates fell 9.8 bps last week, ending the week at 5.77% versus 5.86% the prior week.
6. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 1 point last week, ending at 1,849.
7. TED Spread Monitor – The TED spread fell 2.4 basis points last week, ending the week at 19.7 bps this week versus last week’s print of 22.1 bps.
8. CRB Commodity Price Index – The CRB index rose 3.4%, ending the week at 302 versus 292 the prior week. As compared with the prior month, commodity prices have increased 7.2% We generally regard changes in commodity prices on the margin as having meaningful consumption implications.
9. Euribor-OIS Spread – The Euribor-OIS spread widened by half a basis point to 15.4 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.
10. Chinese Interbank Rate (Shifon Index) – The Shifon Index fell 130 basis points last week, ending the week at 1.98% versus last week’s print of 3.28%. The Shifon Index measures banks’ overnight lending rates to one another, a gauge of systemic stress in the Chinese banking system.
11. Markit MCDX Index Monitor – Last week spreads tightened -1 bps, ending the week at 76 bps versus 77 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.
12. Chinese Steel – Steel prices in China fell 0.4% last week, or 14 yuan/ton, to 3,334 yuan/ton. We use Chinese steel rebar prices to gauge Chinese construction activity, and, by extension, the health of the Chinese economy.
13. 2-10 Spread – Last week the 2-10 spread tightened to 242 bps, -1 bps tighter than a week ago. We track the 2-10 spread as an indicator of bank margin pressure.
14. XLF Macro Quantitative Setup – Our Macro team’s quantitative setup in the XLF shows 0.1% upside to TRADE resistance of $21.51 and 1.3% downside to TREND support of $21.21.
Joshua Steiner, CFA
Jonathan Casteleyn, CFA, CMT
