As the financials ETF, XLF, jumps from down 1.25% to up over 0.75% today, we note that credit markets for the major US banks are anything but exuberant. In the short-term, US bank credit remains significantly weaker, having broken its trend on February 9th, than the broad ETF or individual bank stocks would suggest. We have seen European credit spreads for banks come back off their worst levels - and at the same time, bank stock prices revert downwards to meet that depressed credit perspective. In the US, stocks remain euphoric and credit has not staged any comeback yet inferring a 5-6% drop in XLF (or rally in credit of course). Perhaps the USD-denominated nature of stocks is 'mispriced' relative to the risk-denominated nature of credit spreads as liquidity floats all risk assets on hope of LTRO2 et al.
The upper pane shows US bank stocks (XLF ETF) and an index of the six largest and most liquid US bank CDS (inverted). The higher the credit spread, the more risk, (lower in the inverted chart) and we are nearing the worst levels in six weeks while stock prices are near their highs.
The lower pane shows European credit has retraced and so have stocks from their best levels - but stocks remain 'expensive' relative to credit still (though if we split these into LTRO and non-LTRO banks the difference is greater).
And looking at each of the individual members of the US credit index - it is clear that there is little to no compression in risk in the last week or two as stocks have pushed higher. JPM and WFC appear to have performed the best in credit recently but still the moves are well off recent tights. Its also worth noting that some specific stocks such as BAC and MS are tracking their 200DMA down gradually but unable to break below it for now.
Of course the safest trade is to sell credit protection and sell XLF (or the individual stocks/vol) looking for convergence, but with such large events pending and the over-extension more broadly of equity markets over credit in the last month (post NFP), the odds favor an XLF retracement to credit in the short-run.
Charts: Bloomberg