Some early excitement in credit markets with XOver and senior financials gapping tighter - trying to catch up to equities - has started to show signs of weakness as EURUSD just lost late Friday swing lows (and EURJPY heads for Friday's lows) and sovereign spreads start to decompress. Broad risk markets are indicating more weakness for S&P futures as US TSYs are rallying. The shift in EUR has had its largest impact on Silver so far as dollar strength is a drag on commodities (though we note Brent priced in EUR is +1%) - though copper enjoyed the Asia session gaining over 2.5% from Friday's close. With the Italian bond auction later this morning it is no surprise that EFSF bonds are well off their tight spreads of the morning already and as EUR-USD swap spreads adjust, they are pointing to further deterioration in EURUSD from here. This modest pessimism is already reflected in the short-end underperformance across the European sovereign yield curves as flatteners appear popular once again.
CONTEXT, the broad risk asset basket model for S&P futures which can be tracked in real-time here, is starting to leak lower helped by 2s10s30s flattening and EURJPY compression (as it breaks Friday's lows). Given how much EUR and USD swap spreads have shifted, our model for EURUSD exchange rate is looking for further weakness also - and the decompression in sovereign yield spreads and financial and XOver credit spreads reveal a little less risk appetite than some would have hoped.
The swap-spread term structure model for EURUSD is notably weaker having converged nicely on Friday. It seems CAD is the weakest of the majors though since Friday's close as only JPY, SEK and marginally AUD manage modest gains against the USD.
Credit markets are already giving back considerable amounts of their gap tighter open
But most of the attention is rightly focused on sovereign debt and with 10Y Bunds managing a very modest 1bps compression in yield, only Portugal and Greece are achieving any notable compression - and in context these moves are tiny given their huge yield/spread differentials. Italian 10Y spreads are 6bps tighter but are clinging to the 450bps level - though we notice further flattening in the 2s10s curve (a notably bearish technical). Also adding to some of the technical (flow) in ITA bonds is the basis (the difference between CDS and bond spreads) which gapped notably higher on the open suggesting some hungry basis traders snapped up the 80bps differential - buying CDS protection and buying BTPs) - this is not sustainable risk appetite and we are already seeing the basis leak back from its best levels.
Some perspective on the last two weeks may help in not getting too excited about the moves in Italian bonds. Even though they are significantly off their intraday high yields and spreads, every sovereign is wider relative to Bunds for the month of November:
French 10Y has also managed a 4bps compression over Bunds but remains 15bps wider than last Tuesday's close - so hardly impressive - and EFSF 10Y bond spreads just shifted wider on the day (after being 1-2bps tighter early on). Spanish 10Y spreads are now 3bps wider on the day after being 3bps tighter early on - not helped by the rise in Spanish bank's ECB borrowings this month.
The short-end of the curve is definitely underperforming (the 2nd column in the table shows the performance of each sovereign against German Bunds for 2Y maturities) the back-end across most European sovereigns - the flattener being the low-cost trade of choice for expressing pessimism at EFSF or ECB miracles.
Charts: Bloomberg and Capital Context