Morgan Stanley Joins The "Risk On" Bandwagon
We had more respect for Jim Caron: the man who has traditionally been very objective in his estimation of market risk comes out with this particular measure of "notable risk improvement" - "3M LIBOR set a mere 0.2bp higher than it did yesterday – this morning at 0.53781%." Seriously? He also proceeds to give some other dead cat bounce indicators which are supposed to demonstrate that all is well in the world again. Obviously when confidence in the global Ponzi is dangerously low, the voices of any naysayers must immediately be silenced. We are just confused why hedge funds continue to exist in this "alpha is now extinct" environment: we have gotten to a point where one buys if other buys, Risk On, and vice versa, Risk Off. Why pay someone 2 and 20 to do this is beyond us.
Caron's full note below for those who need yet another bull to add to their daily "objective analysis" list.
We have been using funding metrics such as Libor-OIS and USD funding rates as implied by the EurUSD FX market (see charts below) as a signal for sovereign contagion risk in the markets. To be clear, the funding markets have been functioning well and accessible but just at a higher price. This is an important distinction from 2008 when funding was inaccessible.
What do we need to see to confirm 'Risk-On'? We need to see the Libor rates and Libor-OIS spreads stabilize. Said differently, we need to see funding metrics stop getting worse and start stabilizing, albeit at higher funding level than before to reflect current risks. In today's world of financial reform uncertainty and sovereign risks, Libor-OIS spreads should be wider than history. But it's stability that's most important.
Historically, Libor-OIS traded in times of calm around 10-12bps. That was it's center of gravity. The new center of gravity should be wider today. Whatever it may be, we need to see the market stabilize around that level. Once it does, then we can consider the risks as being priced and then risk appetites should move back to normal levels.
This is what we are watching for, the stability of Libor-OIS and stability in USD funding rates. Today is a step in the right direction as things stopped getting worse than the day before. One day does not a trend make, but it's a data point to take note of.
Our measures of risk showed a notable improvement this morning, with:
- 3M LIBOR set a mere 0.2bp higher than it did yesterday – this morning at 0.53781%
- 3M LIBOR-OIS was roughly unchanged today (and reversing yesterday’s gain for a forward start in September – see 2nd graph below the table)
- 2y swap spreads tightened 6bp to 46bp – tightening from their local wides
- Crude / S&P were up 2.1% and 0.9% as risk markets recovered
- 10y Treasuries sold off 6bp, with 5bp of this due to rising inflation breakevens
- sov CDS was tighter on the day, while gov curves were generally mixed on the day