The Unreported Nonchalance of Global Finance

The disconnect between dominant media narratives and one's personal experience is one of the disconcerting characteristics of our time – suggesting as it does that no-one knows much, and loads of people are bluffing. Right now, we are both wearied and terrified by the imminence of the collapse of European civilization after the epoch-defining failure of its political leaders.

Etcetera.

Or maybe not. Consider a couple of measures of financial risk. First, here's what's happening to global banking risk pricing, according to the 5yr region-wide CDS averaged for Asia, Europe and the US. Today (it turns out), that global average has fallen below a 100-day average which itself is falling. Very often, crossing the 100-day average one way or another tends to define a medium-term trend. This market, then, seems to think that global financial risk is probably slightly in decline.

Then there's the capital risk premium embedded in US 10yr Treasuries (calculated by subtracting 10yr TIPs yields from 10yr Treasury yields). As the chart below shows, although this measure of risk tolerance has been tracking down steadily since mid-March 2012, it remains firmly embedded in 'normal' territory. So far, at least, there is not merely no suggestion of a repeat of the post-Lehmans breakdown, but also no price signal of the sort of distress generated by the first two waves of Euro-crisis (summer 2010, August 2011). In fact, this measure of financial risk-aversion is currently almost exactly at the average is has sustained since the end of 2009.

Of course, this proves nothing, except that generally speaking, the financial world hasn't yet fully bought into the imminence of its own doom. But perhaps there's a good reason for that: I have repeatedly (here for example)  tracked the way in which the major international financial centres have spent the last couple of years attempting to ensure balance-sheets and net cross-border exposures involving European banks (in particular) are restructured to minimise systemic risks. If successful, such sandbagging will provide some short and medium term financial mitigation (though less economic mitigation) from the impact of Europe's banking problems.

But right now, there's an added bonus – risk-pricing for the banking systems of Asia and the US has managed somewhat to decouple from European risk-pricing. We can track this by measuring movements in the 30-day correlation coefficient between daily movements in CDS pricing between Europe's banking system, and banking systems in the US and Asia.  

I started this chart at the beginning of August last year because one can very precisely time the onset of this phase of the Eurozone crisis to that week (see this). And what's striking is that right now, even as we are told  that Eurogeddon is imminent, those correlations have fallen: the correlations with the US financial system are now half a standard deviation below the post-August 11 average; correlations with Asian banks are slightly higher, but nonetheless, at 'normal' levels and falling.

Mainstream narrative notwithstanding, the market is pricing nonchalance.