Dismal End To Day After In Europe

Just when you thought it was safe to go all-in buying financials, stocks, commodities, Chinese IPOs and even Tilson's fund, the last few hours of Europe's day was very disappointing. Commodities took a fairly serious plunge as the dollar strengthened (macro data? or just a reality slap). Credit and equity markets oscillated but legged down into the close and ES also slipped to day's lows as we closed. Sovereigns were on a tear, thanks obviously to a helping hand early on from ECB's SMP program, but even they started to leak back wider in spread and higher in yield into the close. It was not cataclysmic, obviously, but was hardly the follow-through risk-on day that so many had hoped and dreamed of last night and most notably, broad risk assets in general have been leaking lower since US close last night, leaving ES rich relative to CONTEXT.

Equities actually underperformed credit on the day (relatively speaking), which makes some sense given the relative outperformance yesterday. Interestingly Main (European investment grade spreads) and SENFIN (European financial senior debt spreads) were more volatile (judged on empirical beta basis) than the higher risk SUBFIN (subordinated financials) and XOver (high yield credit) as we suspect traders sat on their hands a little and used the lower cost credit instruments to express an opinion as opposed to being highly convicted and risk-on. Senior-Sub differentials widened - again making sense - leading to an optical outperformance of senior spreads (driven mainly by technical flows). All-in-all, not a great follow through at all in credit and equity.

EU Sovs (aside from Portugal) have rallied since the global bailout (dotted vertical line in the chart above) and just as Italy and Spain (and to a lesser extent Belgium) started to leak wider this morning, the market jumped suggesting someone with a bottomless balance sheet and no MtM worries wanted to buy some (cough ECB cough). That helped pull Spain and Italy yields and spreads back to multi-week lows but as we entered the last hour (and they stopped buying) the reality was obvious and we leaked back wider and higher in yield (red ovals). The redemption fund chatter did not seem to help too much.

It wasn't all happiness though as Belgium saw quite notable curve flattening, as did Ireland. We also notice that the CDS-cash basis moving around on several of the peripheral sovereigns - we suspect the gap yesterday and bigger squeeze in Sovereign CDS (and SovX) pushed CDS too far and encouraged some basis traders back in. That would help explain why SovX (the sovereign credit risk index) was 10bps wider on the day (after tumbling 40bps yesterday from its wides) and bonds outperformed. The basis had got very attractive again and encouraged traders to buy bonds and buy protection to lock in a lower risk arb - especially if funding stresses are lower which is also a significant driver of the basis. Point being - some of the strength in sovereign bonds today is likely driven by arbitrage traders (which helps liquidity) and should not be seen as any evidence of safety; if rules are changed again or any CDS actions or PSI rhetoric picks up, expect exits rapidly and the ensuing impact on bonds.

Commodities are not helping and look decidedly weak in terms of risk-on. This adds to concerns that the equity stability in the US is not supported - especially as we see financials start to lag again.


Finally, CONTEXT has been slipping from the last hour of yesterday's US session suggesting the strength in equities remains less than supported (for now) by global risk drivers. A shorter-term calibrated version of CONTEXT sees the intraday market microstructure holding up well for now though as correlations remain lower than normal but still high.

Charts: Bloomberg