Credit Derivatives Research says that US financials outperformed those of Europe for the third week in a row, rallying nearly 30bp (10.4%). Potential for a US government bailout of GSEs remains plausible, the firm says, with both Fannie Mae's and Freddie Mac’s senior spreads narrowing while junior spread widen. Capital structure arbitrage rather than equity bulls are modestly pushing stocks upward, says CDR. This resulted in decreased US counterparty risk as TAF-arbitrage provides US banks with continued profit opportunities.

By contrast, European banks saw their average risk spreads tighten by less than 6bp, contributing to the narrowing of the US-Europe differential from 170bp to around 120bp. BNP Paribas and UBS suffered the most. In addition to a failed covered bond issue by Dexia, interbank rates continue to rise and financials will be further suffocated by the return of liquidity in CDS markets this week, says CDR. Hence, the global economic downturn – with lowered demand for oil, rising short-term interbank rates, and contracting credit – appears to remain a reality.