Global credit mar­ket flashes early warn­ing

The Daily Telegraph - Business - - Front Page - By Am­brose Evans-Pritchard

THE credit mar­kets have sharp an­ten­nae. They is­sued early warn­ing alerts four to eight weeks be­fore each episode of stress over the last 20 years, al­though with sev­eral false alarms along the way.

The shake-out in the US junk bond mar­ket last week had an omi­nous feel for traders and may fi­nally mark the top of the post-Lehman boom in cor­po­rate credit. The ex­u­ber­ant reach for yield is near­ing its lim­its. “It is a sober mo­ment. Peo­ple are sud­denly aware that cen­tral banks are turn­ing se­ri­ous and are not go­ing to keep cre­at­ing stim­u­lus ad in­fini­tum,” said Marc Ost­wald from ADM.

The met­ric watched by mar­kets – the Bank of Amer­ica Mer­rill Lynch high yield op­tion-ad­justed spread – has jumped 40 ba­sis points to 3.8pc over the past two weeks. Black­rock’s iShares HYG fund, the big­gest ex­change traded fund (ETF) for junk debt, fell to a sev­en­month low on Fri­day. The elec­tric power group NRG En­ergy pulled an $870m bond is­sue cit­ing “mar­ket con­di­tions”.

These moves are not large by past stan­dards but they bear watch­ing. “This sell-off is not iso­lated to the US. My in­tu­ition is that some­thing broader is hap­pen­ing,” said Peter Schaf­frik from RBC. The iTraxx Cross­over in­dex mea­sur­ing bond risk in Europe jumped 25 ba­sis points to 248 over five trad­ing ses­sions.

Michael Hart­nett from Bank of Amer­ica ad­vises clients to keep buy­ing the dips for now, de­scrib­ing this as a “dress re­hearsal” for a big cor­rec­tion in global as­set prices next year when the world passes the point of peak mone­tary stim­u­lus. His “Icarus Trade” lives on. The bank’s “Bull & Bear” in­di­ca­tor of op­ti­mism is 7.2, still short of a scream­ing sell sig­nal above 8.0.

In­sti­tu­tional in­vestors are hold­ing back 4.7pc in cash and are not yet fully com­mit­ted. Keep your nerve un­til it falls to 4.2pc, says Mr Hart­nett.

The ini­tial trig­ger for the lat­est jit­ters was a shift at the Bank of Ja­pan, which is hav­ing sec­ond thoughts about pur­chas­ing $4.5bn (£3.4bn) a month of ETFs un­der its quan­ti­ta­tive eas­ing pro­gramme.

The BoJ’s state­ment said “ex­treme mea­sures” aimed at boost­ing in­fla­tion en­dan­ger fi­nan­cial sta­bil­ity and could do more harm than good.

The cau­tion­ary words comes af­ter sev­eral weeks of re­duced pur­chases by the BoJ. The warn­ing ham­mered the Nikkei in­dex, al­though it is still up 18pc since Au­gust. The BoJ owns 72pc of Ja­panese ETF’s and is crowd­ing out the pub­lic share float of sub­stan­tial com­pa­nies such as Fast Re­tail­ing, TDK, and Trend Mi­cro.

A par­al­lel shift is un­der way at the Euro­pean Cen­tral Bank where sev­eral gov­er­nors sug­gested a to­tal halt to QE as soon as next Septem­ber. The ECB has

al­ready an­nounced that it will halve bond pur­chases from €60bn to €30bn a month at the start of 2018. Ire­land’s cen­tral bank chief Philip Lane said there are signs that in­fla­tion is “snap­ping back” and warned that the ECB may have to tighten sooner than peo­ple ex­pect.

The coup de grace came from Wash­ing­ton where the Se­nate Repub­li­cans re­jected the House bill on tax re­form, de­mand­ing a de­lay in cor­po­ra­tion tax cuts un­til 2019. Grid­lock on Capi­tol Hill has chilled an­i­mal spir­its, so far mainly in the credit mar­kets. The S&P 500 eq­uity in- dex is less than 1pc from its peak.

The plan to cut cor­po­ra­tion tax from 35pc to 20pc has been a cru­cial prop for Wall Street. S&P cal­cu­lates that a 1 per­cent­age point fall in busi­ness taxes adds 1.2pc to eq­uity prices, ce­teris paribus. The open ques­tion is to what de­gree in­vestors have pock­eted the tax cuts in ad­vance, leav­ing no mar­gin for dis­ap­point­ment. The S&P 500 is trad­ing at a for­ward price-to-earn­ings ra­tio of 18.3pc, the high­est since the dot­com bub­ble. What events in Asia, Europe, and the US all have in com­mon is a hint that gov­ern­ments can no longer be re­lied on to keep prop­ping up as­set mar­kets.

Se­ri­ous sell-offs in high-yield credit typ­i­cally see spikes of at least 120 ba­sis points, three times last week’s move. But no­body knows where the pain thresh­old lies in the post-QE world. The struc­ture of global debt has been dis­torted by emer­gency poli­cies. The in­ter­est rates of the G4 cen­tral banks are mi­nus 1.5pc in real terms. The quar­tet has pur­chased $11 tril­lion of as­sets since 2009.

Suki Mann from Credit Mar­ket Daily said the ECB has been soak­ing up in­vest­ment-grade bonds, push­ing buy­ers into junk debt. “Peo­ple are buy­ing any­thing they can still find with yield and no­body wants to get left be­hind. Money is still pour­ing in. We’ve smashed all pre­vi­ous records this year for is­suance in Europe,” he said. “Ac­tu­ally it is not even high-yield any more be­cause there is no yield at all. We have never been in a sit­u­a­tion like this be­fore and at some point there will be cri­sis,” he said.

The bub­ble has been as­ton­ish­ing. Yields on the ICE Bank of Amer­ica Mer­rill Lynch euro in­dex for junk debt dropped from 6.4pc in early 2016 to 2pc just be­fore the lat­est sell-off. This is lower than yields on 10-year US Trea­suries, usu­ally re­garded as the bench­mark safe-haven as­set for the world. “There is no doubt that it is a mas­sive bub­ble, and it is only a ques­tion of when it will burst,” said Chris Wang from Run­nymede Cap­i­tal.

Vet­er­ans say the mar­ket moves over re­cent days re­call the mi­cro-tremors in late 2006: the first nag­ging con­cerns about US sub­prime and a lo­cal erup­tion in Ice­land, against a back­drop of eu­ro­zone hubris. The party was to run for an­other half year but the best was over.

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