Equities And EURUSD Outperform As Divergences Increase

Somehow, once again, we managed to rally EURUSD (to 2 month highs) on the back of Greek deal hopes (even as Merkel stomped her feet, Hollande flexed his muscles, and Dallara/Venizelos had nothing to report) which maintained a modicum of support for equity markets (which also got a little late day push from another record-breaking Consumer-Credit expansion) as cash S&P made it to early July 2011 levels. Unfortunately, with Utilities leading S&P sectors, credit diverging wider in investment grade and high-yield, Copper underperforming (post overnight China reality checks), WTI's exuberance (relative to Brent at least), and implied correlation diverging bearishly from VIX, we can't say this was a wholly supported rally. Broad risk-asset proxy (CONTEXT) did stay in sync with ES (the e-mini S&P 500 futures contract) after the European close as Treasuries held up near the day's high yields and FX carry stabilized. Financials lagged with the majors actually underperforming for a change as we note the late-day surge in ES to new highs saw significant average trade size suggesting more professionals covering longs into strength rather than adding at the top. Volume was above yesterday's dismal performance but remained below the year's average so far. Credit and equity vol are back in line and credit has now been flat and underperforming for the last three days (even as HY issuance has been high).


VIX futures (red) dropped with the S&P as they tend to do but the index's implied correlation (green - based on the relative demand for macro index protection over the underlying demand for protection of the underlying portfolio names) suggested more interest in protecting assets up here than adding risk.

We also note (above) that implied skewness (the distributional expectation based on options prices) has normalized somewhat (short-term concerns are almost at their lows while longer-term options still see some risk) while implied kurtosis (below) remains elevated (both short- and longer-term options show heightened concerns at tail risk - though not explicitly a bad/downside tail).

This expectation of an extreme move that remains embedded is less directly relevant than the drop in implied skewness (or bid for downside protection) - which is a little different to options skew for clarity - and suggests there is little more ammunition to drive a rally (compression in vols) as we have come in so far - but of course central bank liquidity is the all-seeing compressor of risk and inflator of assets.


Commodities did trade notably higher off overnight lows (USD highs). Gold and Silver outperformed the USD's weakness and Oil and Silver had similar magnitude shifts intraday of around 3% from low to high as WTI tried to get back to $99.

Equities (blue) (and HYG (green) which managed to recover from its underperformance early on) handily outperformed the broad IG and HY credit indices (as HY (light red) clearly underperformed). This is the second day in a row of HY underperformance and is worth paying attention to as HY was the 'cheaper' asset all the way up until last week (based on our RV models) and has stalled here. HY has seen major issuance this week which is maybe not totally surprising after such a record-breaking January has brough momentum junkies back into the market. The only two better Januaries than 2012 saw major drops in the following February.


Perhaps this stall in vol compression and credit outperformance is due to what Credit Suisse notes as credit and equity vol markets have converged back in line here from a point where credit was notably cheap. Certainly we have seen a lot of discussion of these arb trades and this will slow risk appetite a little, now that it has compressed, even as momentum remains (though admittedly has been flat for almost 3 days now in credit).

FX markets were dominated early by AUD rallying on RBA news which stymied a modest EUR sell-off into a story-of-the-day decent EUR rally which triggered stops and pushed EURUSD back up over 1.3250 back to nearly 2 month highs and the closest to EUR-USD swap-spread model expectation in almost three months (seen above).

Treasuries gave up early gains to end higher in yield on the day and week. The long-bond interestingly outperformed and is only 2.8bps higher on the week while 7s and 10s are more like 5-6bps higher in yield. A 10bps range in 30Y today from low yield to high yield as EUR rallied and stocks rallied didn't seem to extravagant and the modest rate rally into the close suggested this was not risk-off sentiment rotating into stocks by any chance.

All-in-all, more canaries, more momentum, more weak-USD strong-gold driven stock buying, more rumors of nothing at all in Europe that push stocks inexorably higher. Perhaps the most important of all the divergences we discuss above is the fact that the major financials saw CDS widen modestly and equities selloff a decent amount (of course relative to their YTD move, hardly at all) into the close.

Charts: Bloomberg and Capital Context