It has been a few weeks since we did our roundup of global risk indicators, so let’s catch up today. We have our usual list below along with a “Red, Yellow, Green” indicator of what each tells us about macro financial system risk.
#1: TED Spreads. The difference between 3-month LIBOR and 3-month Treasury yields, which is one measure of stress in the global financial system.
Verdict – Green light:
- The most recent reading is 27 basis points, right in the middle of the 1-year range of 13 bp to 48 bp. The latter occurred at the end of 2018 as global markets were in turmoil.
- See the chart here: https://fred.stlouisfed.org/series/TEDRATE
#2: US Corporate Bond Spreads. We covered these recently, showing that they are not reliable recession indicators. Still, they do inform investment narratives about the risk tolerance of fixed income markets.
Verdict – Green light:
- Investment Grade corporate spreads have been declining since the start of June and now sit at 2019 lows of 115 basis points.
- IG chart here: https://fred.stlouisfed.org/series/BAMLC0A0CM
- High Yield corporate spreads of 393 basis points today are not yet at their 2019 lows (364 in mid-April), but are certainly tighter than either early June 2019 (470 bp) or January 4th 2019’s spike high of 544 bp.
- HY Chart here: https://fred.stlouisfed.org/series/BAMLH0A0HYM2
- Several clients have asked about BBB corporate debt spreads, so we have included that chart here. The story is very much the same as IG generally, sitting at 2019 lows of 148 basis points.
#3: Italian 10-year sovereign debt yields. At 133% debt-to-GDP, Italy is the riskiest major European country in terms of credit quality. Spain and France are at 97-98%, and Germany is down at 61%. That makes Italy debt the marginal issuer of Eurozone paper.
Verdict: Green light, maybe too green:
- At a current yield of 1.57%, Italian bonds haven’t seen similar levels since October 2016.
- Credit the belief that the ECB will be in the market aggressively buying these bonds (and many others) over the next 12 months.
- Since this is a “you have to see it to believe it” indicator, here is the 5-year chart:
#4: Offshore yuan/dollar exchange rate. Markets see this one barometer of how well/poorly the Chinese economy is faring as the US-China trade negotiations drag on. Common wisdom has it that if the yuan/dollar exchange breaks through 7.0 (meaning an all-time weak reading) it means Chinese policymakers are struggling to maintain the country’s economic growth and stability.
- The current exchange rate is 6.88, and Bloomberg recently called the yuan “the world’s dullest currency”. True enough – the last 3 weeks have seen it trade in a remarkably tight band.
- Given all the talk of lower Fed Funds and the rally in European bonds (point #3), you would expect to see the yuan strengthen since this is the typical pattern for emerging market currencies during a developed economies easing cycle.
- When an asset fails to rally on good news, it is a warning sign that something else is holding it back.
- Chart here: https://www.cnbc.com/quotes/?symbol=CNH=
#5: Federal Reserve trade-weighted dollar index. We think this is the best measure of dollar strength since it is based on actual cross border trade and the index changes over time as commercial relationships fluctuate.
- By this measure the dollar is within 2% of its all time high (early 2002) just now and has been within 1% of the old highs in just the last month.
- In the markets section we outlined what a strong dollar/weak global economy has meant to US companies with an outsized international footprint, and the trade-weighted dollar index puts some context around that headwind.
- Chart back to 1995 here:
Summing up: we make it 3:2 in terms of the ratio of green – yellow indicators. A slim majority, in other words, and no “red” lights flashing. The sharp-eyed reader will see that the “green” lights are in markets where central bank policy can affect prices (TED Spreads, corporate bond prices, Italian sovereign debt). The yellow ones are at the intersections of currency markets, where even a central bank’s firepower has its limits.