The unerring belief that powers greater than mere mortals will vanquish the enemy of lack-of-bank-capital this weekend was enough to spur a significant turnaround in European stocks and spreads as they headed towards the close. While optically, the strength in senior financials spreads appears wondrous, we note that subordinated spreads are underperforming seniors significantly (when one would expect them to be outperforming if all was really well) and broad equity indices (and credit indices) only managed to get back to marginally unchanged. Sovereign risk remains notably wider still - which has the smell of a bailout/nationalization risk-transfer to it in our ever so humble opinion.
As we have been mentioning for a few days now, the scramble for macro hedges had pushed all the major credit indices notably wide of their fair-value and this afternoon (in Europe) had the feel of rotation from the macro index hedges to individual more discriminatory hedges (or more simply selling underlying positions as higher beta and lower quality credits were net sold and underperformed. For example, XOver ended the day -9bps at 836bps while intrinsics (the fair-value based on the underlying names in the XOver portfolio) widened over 10bps. The same pattern of single-name underperformance of indices is evident in Senior financials, Main (Europe's investment grade index) and also in HY and IG over here - so we wouldn't be getting too excited by this move quite yet.
On the topic of discrimination - not all European financials were doing well today with Banco Popolare, Lloyds TSB, Credit Suisse, and UBS all wider on the day as SocGen rallied but remains inverted and BNP Paribas flat across its term structure (never a good sign). Furthermore, the underperformance of Subs to seniors suggests some are lining up more in the senior-sub decompression space (even if they weren't already) and we note that at current levels, a 47% recovery for senior bondholders would imply a ZERO recovery for subordinated bondholders.
Across all the sovereigns that we track, only Italy, Spain, and France are modestly tighter on the day but we do note that on a GDP-weighted basis Sovereign risk improved very modestly -1bps to 310bps for Europe. CEEMEA remains hit hard on the day as do the majority of EM sovereigns (Ukraine +100bps to 875bps and Czech Republic +29bps to 181bps) as are AsiaPac (Vietnam +25 to 480bps).
Away from credit, FX markets have been volatile - following the overnight G-20 comments and inevitable disappointment but the EUR remains positive on the day though is leaking abck weaker as we close.
This modest dollar weakness is doing very little for PMs - even as Copper and Oil rebound from their week-lows. We suspect the continuing selloff in Gold and Silver is due to the ever louder liquidation/redemption rumors at you-know-who.
And finally in the US TSY complex, we have started to see some covering back as 5Y yield actually turned higher post Bernanke for a moment and 30Y pulls back from record low yields.
All-in-all, it seems like today was a pause day as opposed to a bounce day and much of the apparent strength ion risk assets can be attributed to technicals and rotation by professionals after a chaotic week. We only hope they get what they want over the weekend but suspect they will not.