Easy central bank policy continued to help offset economic growth concerns last week. While U.S. third-quarter GDP came in at a low 1.5%, it only added to investor optimism about the Federal Reserve keeping rates near zero. Investor reaction was such that the TED spread fell an impressive -7 bps to 25. Additionally, Chinese bank CDS continued to tighten while the Chinese interbank rate dropped another -11 bps following the PBOC announcing it would cut rates and reserve requirements. This was in spite of the slowest GDP growth since the financial crisis. Our warning of caution: growth is slowing.
Given investors' positive reaction to central bank policy, our heatmap below is predominantly green for both the short and intermediate terms. Long-term readings are mixed.
Financial Risk Monitor Summary
• Short-term(WoW): Positive / 4 of 12 improved / 0 out of 12 worsened / 8 of 12 unchanged
• Intermediate-term(WoW): Positive / 7 of 12 improved / 2 out of 12 worsened / 3 of 12 unchanged
• Long-term(WoW): Negative / 2 of 12 improved / 2 out of 12 worsened / 8 of 12 unchanged
1. U.S. Financial CDS – Swaps tightened for 13 out of 27 domestic financial institutions. Reaction was positive to the Federal Reserve's announcement that it would keep rates near zero and the subsequent low GDP reading of 1.5% with the median CDS spread tightening from 78 to 76 bps.
Tightened the most WoW: MMC, MBI, AXP
Widened the most WoW: CB, ACE, AIG
Tightened the most WoW: MMC, TRV, ALL
Widened the most MoM: CB, RDN, GNW
2. European Financial CDS – Swaps mostly widened in Europe last week, although the movement was muted. The median spread held steady at 75 bps.
3. Asian Financial CDS – Chinese financial swaps continued to tighten, following the PBOC's decision to cut interest rates and reserve requirements in the prior week.
4. Sovereign CDS – Sovereign Swaps mostly tightened over last week. However, Portuguese swaps widened as the country's prime minister was sworn in for a second term as the head of a minority government that is expected to last less than two weeks given challenges from the socialist majority.
5. Emerging Market Sovereign CDS – Emerging market swaps mostly widened last week; Brazilian swaps, however, backed off -15 bps from their recent highs.
6. High Yield (YTM) Monitor – High Yield rates were unchanged, ending the week at 7.39%.
7. Leveraged Loan Index Monitor – The Leveraged Loan Index fell 3.0 points last week, ending at 1846.
8. TED Spread Monitor – The TED spread fell 7 basis points last week, ending the week at 25 bps this week versus last week’s print of 32 bps.
9. CRB Commodity Price Index – The CRB index was unchanged, ending the week at 196. As compared with the prior month, commodity prices have increased 0.8%. We generally regard changes in commodity prices on the margin as having meaningful consumption implications.
10. Euribor-OIS Spread – 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. The Euribor-OIS spread was unchanged at 12 bps.
11. Chinese Interbank Rate (Shifon Index) – The Shifon Index fell 11 basis points last week, ending the week at 1.80% versus last week’s print of 1.91%. The Shifon Index measures banks’ overnight lending rates to one another, a gauge of systemic stress in the Chinese banking system.
12. Chinese Steel – Steel prices in China rose 0.6% last week, or 12 yuan/ton, to 2150 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 142 bps, -3 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 2.1% upside to TRADE resistance and 2.8% downside to TRADE support.
Joshua Steiner, CFA
Jonathan Casteleyn, CFA, CMT