Credit Spread Stuff

September 30th, 2014 8:09 pm | by John Jansen |

Via Merrill Lynch Research:


  • Economy up, risk assets down. As our rates strategists have highlighted, September stands as the month where longer term interest rates finally go up in reaction to stronger than expected economic data, see The long-end mystery. This most likely as strong Treasury demand technicals from the beginning of the year (China, banks, money managers, etc.) have weakened substantially. However, risk assets are troubled by this development – especially credit and especially high yield. Thus, while in September 10-year interest rates rose 16bps, stocks declined 1.4%, IG credit spreads widened 7bps while high yield spreads were as much as 67bps wider (cash indices through 9/29). In contrast, during the first eight months of the year 10-year rates plunged 69bps while stocks rose 9.9% and IG and HY spreads each tightened 16bps. You would think that an improving economy is good for risk assets – and it most certainly is longer term – but there will be periods like September where markets struggle as rate concerns motivate the unwind of crowded trades. How long the current weakness persists depends in no small way on Friday’s employment report. In the short term good news is bad news, bad news is good news. Hans Mikkelsen (Page 5)
  • Earnings, M&A to drive October supply. As expected, high grade issuance volumes were heavy in September, totaling $121bn. This is the fifth-busiest month on record (going back to 1998, excluding government guaranteed issuance), and the second busiest this year after March, when issuance was $122bn. October, however, is seasonally a slower month due to earnings-related issuance blackouts. Most of the reporting is scheduled during the weeks of October 20 and 27th. As a result, supply volumes will likely be more concentrated during the first week of the month, before blackouts, and in the last week – after enough companies report earnings. There is also risk that a sharp rise in interest rates and corresponding market volatility could lead to significantly less favorable market conditions for supply next month. On the other hand issuance related to acquisitions will likely pick up in 4Q, including potentially in October. This is due to M&A volumes accelerating significantly in 2Q and 3Q of this year (see more details below). Hence M&A related issuance creates upside risk to October (as well as November) supply volumes. Due to these uncertainties we expect October supply in a relatively wide $50 to $100bn range.Yuriy Shchuchinov (Page 6)
  • Increase in CDX IG net longs. Non-dealer investor’s net long-risk positioning in CDX IG increased notably last week, while HY only rose modestly. Hence, the net long positioning in CDX IG rose to $22.5bn last week (as of September 26th) from $17.2bn in the prior week. At the same time, the net long positioning in CDX HY rose to $3.9bn last week from $3.4bn in the prior week. Assuming that the CDX HY is around four times more volatile than CDX IG in terms of returns, the current $3.9bn net long for CDX HY corresponds to about $15.6bn CDX IG net long in terms of risk, which is still somewhat below the current $22.5bn reading for CDX IG


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