Something strange is happening in European risk markets this week. While that sentence is entirely 'normal' for what has become a diverging/converging flip-flopping correlation microstructure but the clear trend this week has been European Sovereign derisking and European Stock rerisking. The Bloomberg 500 index (that tracks a broad swathe of European stocks) is up 0.75% from Christmas Eve (and 1.6% from yesterday's lows) while 10Y sovereign spreads are wider by 10 to 30bps in the same period. France stands out as one of the worst performers - more than 25bps wider this week alone. Only Spain is notably improved on the week (-17bps) but all 10Y sovereigns are well off their best levels as stocks make new highs. Whether this is a front-run on asset rotation into the new year or expectations of the same risk-on ramp-job we saw on the first trading of this year is unclear - we do remind those front-runners that mutual fund cash levels are significantly lower this year than last. It is clear that yet another 'sensible' correlation (such as BTPs to equities) has broken but when volumes return and the reality of the huge supply calendar we face in the next month alone sinks in, perhaps equity ebullience will pull to bond bereavement. If stocks are reacting to a quasi-QE from the ECB, why wouldn't sovereigns who are the direct beneficiaries in that surreal LTRO-driven-carry trade.
The highly correlated relationship between European stocks and sovereign risk has decoupled in the last week or so - and not in a good LTRO-carry-trade-driven way.
Stocks are up nicely this week...
but sovereigns are all (except Spain for now) wider on the week post Christmas. The French 10Y is the stand-out to us though - quietly widening almost 26bps this week (from 105bps to 131bps) or 25%...and BTPs are 36bps wide of their tights from Wednesday. Hardly a reassuring signal from the markets - even with the ECB rumored to have been buying this week.