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June 2022 | Issue 246

Duration, decompression and dispersion disconnects grow

Dan Alderson
Deputy editor
Investors’ reassessment of the time they may need to hold on to positions — as well as the limited opportunity for some borrowers to access new capital — are adding to a growing list of factors causing credit market prices to disconnect.
Central banks hiking rates fast while withdrawing market support has been key to overall market widening in 2022, but there is a growing sense this theme may overshoot — if it has not already. And there has been little distinction so far about where pressure is applied through the sell-off, with curves largely intact, correlation high, and a daily give-and-take between investment grade and high yield. But greater differentiation and directionality is on the way, say sources.
“More decompression is on the horizon, which would hurt parts of the high yield market,” says Alex Eventon, portfolio manager at Edmond de Rothschild. “That can become more of a theme when IG borrowers are able to access the primary market, but specific high yield companies are shut out and the clock is running.”
“Even on down days it is hard to source bonds”
Alex Eventon, Portfolio manager | Edmond de Rothschild
Rates stability appears unlikely in the coming weeks, but consensus has grown among strategists that credit has achieved the right pricing for macroeconomic risks.
One disconnect that has arisen has been between cash bonds and CDS. This stems from a disrupted primary market, particularly for high yield, but also severely impaired secondary cash trading.
“Liquidity is poor, both for entry and exit,” says Eventon. “Even on down days it is hard to source bonds — you could see them marked down a point, but can’t always buy at that level because of large bid axes.”
CDS indices hit their widest levels since 2020 on 19 May, when CDX HY dropped 1.25 points on the week and 6.75 points from the month’s start, while the HYG ETF only fell 0.75 and 2.5 points, respectively. IHYG was flattish on the month, against a two point drop in iTraxx Crossover.
Investors’ and credit strategists’ expectation of decompression between high yield and IG credit comes despite a general assessment that the default cycle is still some way off.
But CDX HY has registered its first credit event since mid-2020, with Talen Energy Supply filing for chapter 11 bankruptcy protection. This puts the spotlight on base correlation, which remains high at 0.37 in HY equity 0-15%.
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Global credit funds & CLO's
June 2022 | Issue 246
Published in London & New York.
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