The divergence between credit and equity marksts that we noted into the European close on Friday closed and markets sold off significantly. European sovereigns especially were weak with our GDP-weighted Eurozone credit risk index rising the most in six weeks. High beta assets underperformed (as one would expect obviously) as what goes up, comes down quicker. Stocks, Crossover (high-yield) credit, and subordinated financials were dramatically wider. Senior financials and investment grade credit modestly outperformed their peers but also saw one of the largest decompressions in over a month (+5.5bps today alone in the latter) as indices widen back towards their fair-values. The 'small moderation' of the last few weeks has given way once again to the reality of the Knightian uncertainty Europeans face as obviously Portugal heads squarely into the cross-hairs of real-money accounts looking to derisk (10Y Portugal bond spreads +224bps) and differentiate local vs non-local law bonds. While EURUSD hovered either side of 1.31, it was JPY strength that drove derisking pressure (implicitly carry unwinds) as JPYUSD rose 0.5% on the day (back to 10/31 intervention levels). EURCHF also hit a four-month low. Treasuries and Bunds moved in sync largely with Treasuries rallying hard (30Y <3% once again) and curves flattening rapidly. Commodities bounced off early Europe lows, rallied into the European close and are now giving back some of those gains (as the USD starts to rally post Europe). Oil and Gold are in sync with USD strength as Silver and Copper underperform - though all are down from Friday's close.
[17]
GDP-weighted sovereign risk across all of Europe has been range-bound for four months and this last rally never made it back to the low end of the range. Today's jump (in 10Y bond spreads) is the biggest in six weeks with Italy +26bps, Portugal +224bps, and Spain +14bps.
[18]
Portugal's bonds underperformed CDS on the day as the basis exploded downward (illiquidity). Portugal CDS are trading 42/43% upfront now against 5Y bonds priced at 49.725 (22.6% yield) offers those who still believe CDS are a useful insurance contract some very nice upside for the basis package and while the discrepancies are small for now, we are starting to see some differentiation in Portuguese local vs non-local bonds at the longer-end. In the belly, it is clear that the Cash-CDS basis package is bringing some interest as the Feb 2016 Portugal issue (closest to 5Y CDS maturity) outperformed its peers today (and is a little rich now to the non-local law Oct 2015 bond). Away from Portugal, the differentiation between local and non-local law bonds is increasing with Italy, Spain, Greece, and Ireland all showing Non-local law bonds trading at significant premia to local-law now.
[19]
European stocks and credit underperformed significantly (worst day in six weeks in most cases) and we are seeing the higher beta indices underperform (high beta is not a uni-directional bias as some seem to think). The clear up-in-quality (Senior and IG, Bunds/TSYs) and up-in-capital structure (from equities to bonds) suggests the last few weeks of momo chasing may be coming to an end.
Charts: Bloomberg