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Takeaway: While global markets pushed higher in response to the ECB, we remain skeptical of the nature and durability of this rally.

MONDAY MORNING RISK MONITOR | GREEN DOESN'T MEAN GO - RM11

Key Takeaway:

Global markets reacted with broad optimism to the ECB announcing that it would cut rates and expand asset purchases last week. Our heatmap below reflects this with an overwhelming number green "risk on" signals across the short and intermediate term durations. CDS tightened globally, the high yield YTM tightened by 15 bps, the leveraged loan index rose by 20 points, and the TED spread and Euribor OIS spreads tightened by 5 bps and 4 bps respectively. Meanwhile, the price of Chinese steel jumped by 286 Yuan/ton (+13% W/W).

While the drumbeat in the short-term has been positive now for 3-4 weeks, we remain concerned that central planners ability to fight slowing growth is in secular decline (see Japan). We advise caution against getting over your ski tips on the bullish side.

Current Ideas:

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Financial Risk Monitor Summary

• Short-term(WoW): Positive / 9 of 13 improved / 1 out of 13 worsened / 3 of 13 unchanged
• Intermediate-term(WoW): Positive / 9 of 13 improved / 1 out of 13 worsened / 3 of 13 unchanged
• Long-term(WoW): Negative / 1 of 13 improved / 4 out of 13 worsened / 8 of 13 unchanged

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1. U.S. Financial CDS – Swaps were tighter across the board for US Financials last week. Positive US labor data coupled with the ECB's announcement for rate cuts and increased asset purchases drove the median US financial swap tighter by -8 bps to 95.

Tightened the most WoW: AIG, AXP, C
Widened the most WoW: AON, TRV, ALL
Tightened the most WoW: AIG, MET, PRU
Widened the most MoM: SLM, MBI, AGO

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2. European Financial CDS – European investors reacted with broad optimism to the ECB's announcement last week, and swaps tightened across the complex. The median swap fell by -25 bps to 104.

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3. Asian Financial CDS – Asian Bank CDS were tighter across the board last week. ICICI Bank of India saw the biggest improvement W/W at -20 bps to 182.

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4. Sovereign CDS – Sovereign Swaps mostly tightened over last week. Portuguese swaps tightened the most, by 17 bps to 252.

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5. Emerging Market Sovereign CDS – Emerging market swaps mostly tightened last week. Propelled by optimism over the effects that ECB stimulus might have on global economic growth, the median swap for these producer economies tightened by 13 bps to 181.

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6. High Yield (YTM) Monitor – High Yield rates fell 15 bps last week, ending the week at 7.84% versus 7.99% the prior week.

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7. Leveraged Loan Index Monitor  – The Leveraged Loan Index rose 20.0 points last week, ending at 1833.

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8. TED Spread Monitor  – The TED spread fell 5 basis points last week, ending the week at 31 bps this week versus last week’s print of 37 bps.

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9. CRB Commodity Price Index – The CRB index rose 5.4%, ending the week at 174 versus 165 the prior week. As compared with the prior month, commodity prices have increased 8.2%. We generally regard changes in commodity prices on the margin as having meaningful consumption implications.

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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 4 bps to 11 bps.

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11. Chinese Interbank Rate (Shifon Index) – The Shifon Index was unchanged at 1.95% last week. 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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12. Chinese Steel – Steel prices in China rose 13.2% last week, or 286 yuan/ton, to 2458 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 103 bps, 2 bps wider than a week ago. We track the 2-10 spread as an indicator of bank margin pressure.

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14. CDOR-OIS Spread – The CDOR-OIS spread is the Canadian equivalent of the Euribor-OIS spread. It is the difference between the Canadian interbank lending rate and overnight indexed swaps, and it measures bank counterparty risk in Canada. The CDOR-OIS spread was unchanged at 40 bps.

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Joshua Steiner, CFA



Jonathan Casteleyn, CFA, CMT