The chart below shows the trends in bank credit risk or the risk of default by banks for Europe and the US and there’s a clear divergence. Since 2015 European bank CDS pricing has been on a fairly steady uptrend. The exception was the global panic earlier this year where it became a spike! And that’s often how it goes with these sort of metrics, nothing happens for a while and then everything happens…
Bank Default Risk Diverging
Before delving into implications, it’s worth pointing out the technical notes on the graph – it’s tracking average CDS (Credit Default Swap i.e. insurance against a default on its – in this case – senior debt) pricing for banks with such data in Europe and the US. The steady rise in the European can be explained by rising political risk, ongoing issues with particular banks, still high non-performing loans in some countries, and perhaps just a normalisation drive as well since European bank default risk pricing was probably too low previously.
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As for the US a number of factors are in play, for one the overall environment has become more favourable for banks e.g. with some bank ETFs up over 50% of the lows earlier this year. Factors such as rising bond yields (usually a good thing for banks!), an improving economy, and even a potential move to more favourable regulation mean that US banks have had a much more friendly backdrop.
As to what’s next, well you get nervous when you see a metric like this making a steady uptrend as it can go from steady to spiking, but if it’s merely a return to more appropriate pricing from being too low then it could be more benign. Meanwhile the US index doesn’t have too much further to go before it will start to look a little too quiet or complacent…
Article by Top Down Charts