Europe Weak As Equities Stall On 'Safety' Bid
Some late-day covering as traders flattened out added a little lipstick to a pig-like day for European equities and sovereign credit as non-sovereign credit outperformed (but hides a few under-currents). Markets opened gap-up with credit notably ahead of equities - another ugly jump tighter in everything for all those option traders - but that was the best of the day as XOver (high-yield European corporate debt) and senior & subordinated financial credit tumbled all day. Main (investment grade credit in Europe) outperformed as investors sought the safety of this up-in-quality trade but most notably we suspect was the decompression trades in XOver-Main (i.e. traders positioning for a bearish spread widening between investment grade and high yield spreads). Financials ended wider, following their sovereign's very notable deterioration today, as the banks swung very notably from high to low. Liquidity measures improved but that seems very clearly driven by the Fed swap lines as opposed to improved conditions and we note that as Europe closed, ES managed to scramble back up to VWAP - and is trading a little ahead of broad risk assets.
Equities (the dark blue line) show clear underperformance on the day. Credit was more 'capitulative' at the open and we note that financials (red and light blue) closed wider (lower in the chart) on the day - well off the day's tights. XOver (black) sold off all the way to unch and bounced a little into the close but Main (orange line) outperformed handily (even despite its huge richness to its intrinsic value). This smells suspiciously like a combination of a notable non-financial up-in-quality bid (i.e. hardly a risk hungry perspective) and pressing on XOver-Main decompression trades (notably bearish position).
To illustrate the XOver-Main decompression, using a 4.5x delta for Main vs Xover, as we rallied Main (the quality end of credit in Europe) has outperformed very significantly. The lower pane shows an adjusted differential to get a better sense for this disconnect. If risk appetite was high we would expect the higher beta XOver to have compressed relatively more. This points to much less risk appetite than optics might suggest.
European sovereign spreads were ugly today (with bonds notably underperforming CDS - fitting with our theme from yesterday of basis traders starting to step away). Chatter of ECB intervention stabilized the sell-off in the last hour or two, and spreads remain notably tighter for the most risky names on the week, but today's movement was very significant - especially given our earlier discussion of the dissonance between expectations of a solution and the clear non-expectations in risk positioning.
Gilts (and cable - GBP) rallied notably on the day as risk shifted to the safety of Blighty and EURGBP was in play even as EURUSD ended almost unch on the day.
Commodities slid notably overnight with oil testing under $100 briefly but Gold bucked the trend and rallied on the day - though still modestly lower on the week.
Broadly, risk assets were in sync with ES as we sold off and as we rally back here after the European close, CONTEXT (the broad risk asset basket) is now less supportive of this upswing.
All-in-all, it was definitely a risk-off day Europe and any optimism from the strength in IG credit is misplaced as this is akin to the bid for Gilts and simply a rotation to safety as opposed to an active risk-seeking position.
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