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    MARKET EDGES

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Takeaway: Commodity prices are the key risk to growth at this point, while interbank systemic risks seem to be subsiding for now.

Weighing the Pros & Cons:

The short-term setup in Financials remains mixed with five measures posting short-term improvement and three measures going the wrong way. The three areas of concern are commodity prices, high-yield rates and Chinese interbank risk. Of these, rising commodity prices is the measure we would ascribe the most significance to. We expect that today's rising commodity prices will begin weighing on economic growth in coming months and that should affect both the Fed's tapering calculus and the average consumer's spending decision process. 

On the other hand, two of the measures we had been concerned about for the last month, the TED Spread and Euribor-OIS, are both now flattening or improving suggesting that interbank risk in the US and Europe is now stabilizing. In light of the early-February EM scare and the ongoign situation in the Ukraine, it's noteworthy that these gauges of systemic risk are showing no further signs of upward trajectory. Also noteworthy is the fact that, in light of the Friday payroll report, the 2-10 yield spread widened out 9 bps last week and is now +4 bps on a month-over-month basis, which is positive for the Financials. That said, at 242 bps the yield spread remains well off its January 1, 2014 recent high of 265 bps. 

Key Points:

* 2-10 Spread – Last week the 2-10 spread widened to 242 bps, 9 bps wider than a week ago. We track the 2-10 spread as an indicator of bank margin pressure.

* Euribor-OIS Spread – The Euribor-OIS spread tightened by 3 bps to 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. 

* CRB Commodity Price Index – The CRB index rose 1.9%, ending the week at 307 versus 302 the prior week. As compared with the prior month, commodity prices have increased 7.0% We generally regard changes in commodity prices on the margin as having meaningful consumption implications.

* High Yield (YTM) Monitor – High Yield rates rose 10.5 bps last week, ending the week at 5.71% versus 5.60% the prior week.

 

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 / 8 of 13 improved / 3 out of 13 worsened / 2 of 13 unchanged

 • Long-term(WoW): Positive / 6 of 13 improved / 3 out of 13 worsened / 4 of 13 unchanged

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1. U.S. Financial CDS -  GS widened by 1 basis point and Sallie Mae widened by 6 bps, but aside from those two reference entities, swaps were mostly tighter week over week. Overall, swaps tightened for 20 out of 27 domestic financial institutions.

Tightened the most WoW: MBI, AGO, MTG

Widened the most WoW: ACE, AON, SLM

Tightened the most WoW: MBI, AGO, BAC

Tightened the least MoM: AON, ACE, XL

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2. European Financial CDS - The big mover in European swaps last week was Sberbank of Russia, which widened 72 bps to 286 bps from 214 bps. Russia's largest bank has often been a good indicator on geopolitical as well as commodity pressures. Elsewhere across Europe, the Financials were much more sanguine with broad-based improvement.

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3. Asian Financial CDS - Asian Financial swaps were tighter across the board last week as well with the exception of a few Japanese financials that were unchanged.

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4. Sovereign CDS – Sovereign swaps were tighter across the globe last week with the sole exception of the US, where swaps were unchanged at 30 bps. Europe put up broad-based improvement in spite of turmoil in peripheral Ukraine.

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5. High Yield (YTM) Monitor – High Yield rates rose 10.5 bps last week, ending the week at 5.71% versus 5.60% the prior week.

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6. Leveraged Loan Index Monitor – The Leveraged Loan Index rose 1.0 points last week, ending at 1851.

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7. TED Spread Monitor – The TED spread was unchanged last week at 18.8 bps this week versus last week’s print of 18.77 bps.

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8. CRB Commodity Price Index – The CRB index rose 1.9%, ending the week at 307 versus 302 the prior week. As compared with the prior month, commodity prices have increased 7.0% 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 tightened by 3 bps to 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 21 basis points last week, ending the week at 2.055% versus last week’s print of 1.846%. 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 were unchanged at 73 bps. 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 were unchanged last week at 3,303 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, 9 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 1.1% upside to TRADE resistance and 2.3% downside to TRADE support.

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Joshua Steiner, CFA

Jonathan Casteleyn, CFA, CMT