Risk measures were mixed last week with our summary table below now showing an even balance of improving/worsening factors over the intermediate term. On a short-term basis, the skew is more favorable at 5 to 1.
Clearly, the main event is the long-awaited liftoff by the Fed, catalyzed by Friday's nominally better than expected NFP report. There's some worthwhile debate over whether This Time Is Different on this rate hike, i.e. after so many years of Zero has the country moved to a position of net asset sensitivity or are we still net liabilty sensitive as we have been throughout cycles past. We know banks are asset sensitive (see Call Reports) as are savers, but will longer-term credit demand wane by enough to offset the benefits? Obviously this depends in large part on what happens to the curve. We remain of the view that the curve will flatten as it did from mid-2004 to mid-2006 when the Fed tightened 17 consecutive times raising the Fed Funds rate from 1.00% to 5.25%. During that period of tightening the 30-YR Fixed Rate Mortgage ended about where it started, at ~6%.
Areas of ongoing weakness include Chinese Steel (down another 2.7% on the week and -8.8% on the month), which is still our proxy for China's economy. Also, high yield and levered loans continue to sell off, driven at least partially by the weakness in the energy segment of the market. High yield YTM has backed up 53 bps on the month now, to 7.95%.
Financial Risk Monitor Summary
• Short-term(WoW): Positive / 5 of 12 improved / 1 out of 12 worsened / 6 of 12 unchanged
• Intermediate-term(WoW): Negative / 5 of 12 improved / 5 out of 12 worsened / 2 of 12 unchanged
• Long-term(WoW): Negative / 1 of 12 improved / 3 out of 12 worsened / 8 of 12 unchanged
1. U.S. Financial CDS – Swaps tightened for 15 out of 27 domestic financial institutions on Friday's employment report, which came in better than expected with 211k jobs added.
Tightened the most WoW: ACE, ALL, CB
Widened the most/ tightened the least WoW: WFC, SLM, SLM
Tightened the most WoW: LNC, ACE, MMC
Widened the most MoM: CB, AXP, PRU
2. European Financial CDS – Swaps mostly tightened in Europe last week despite the ECB's stimulus announcement falling short of expectations.
3. Asian Financial CDS – Two of three Chinese bank swaps tightened following the IMF's decision to make the yuan a lending-reserve currency. Also in India, two of three bank swaps tightened. Indian bank swaps were bolstered when a panel run by the Indian Finance Ministry's chief economic adviser proposed a simple 17% goods and services tax last week.
4. Sovereign CDS – Sovereign swaps mostly tightened over last week. Portuguese sovereign swaps tightened significantly more than others, by -11 bps to 176.
5. Emerging Market Sovereign CDS – Emerging market swaps mostly widened last week given the threat of a U.S. Fed rate hike. Brazilian sovereign swaps widened the most, by 19 bps to 446.
6. High Yield (YTM) Monitor – High Yield rates rose 1 bps last week, ending the week at 7.95% versus 7.94% the prior week.
7. Leveraged Loan Index Monitor – The Leveraged Loan Index fell 2.0 points last week, ending at 1826.
8. TED Spread Monitor – The TED spread was unchanged last week at 25 bps.
9. CRB Commodity Price Index – The CRB index fell -1.3%, ending the week at 183 versus 186 the prior week. As compared with the prior month, commodity prices have decreased -4.1%. 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 tightened by 6 bps to 10 bps.
11. Chinese Interbank Rate (Shifon Index) – The Shifon Index was unchanged over last week, ending the week at 1.79%. 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 fell 2.7% last week, or 54 yuan/ton, to 1963 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 widened to 133 bps, 3 bps wider 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 and 2.2% downside to TRADE support.
Joshua Steiner, CFA
Jonathan Casteleyn, CFA, CMT