In the immortal words of Walter Sobchak:
Has the whole world gone crazy?! Am I the only one around here who gives a sh*t about the rules?!
It wasn’t 24 hours ago when I observed, with more than a little alarm, that French IG corporate debt comprises nearly a quarter of the € IG market. So what that means is that if you’re in € IG credit, you have to figure out how to hedge something like €410 billion in French corporate debt against a possible redenomination event thanks to Marine Le Pen’s pledge to take France out of the EMU.
How the f*ck do you hedge that? How do you hedge against a corporate credit event in 23% of the entire universe of € IG debt? How do you sell €410 billion in corporate debt in a panic?
Well, you don’t.
And here’s the stupidest thing about this. The € IG market knows goddamn well that this is a problem. Just look at the correlation between the OAT-bund spread and iTraxx Main:
But incredibly, even though French sovereign credit risk is clearly driving € IG spreads, those very same € IG spreads (well, that’s not technically right as the chart below is the cash market and the chart above is synthetic credit, but you get the idea) aren’t blowing out commensurate with rising EU political risk:
Take a second to think about what I just said. € IG is the most highly correlated with French sovereign credit risk (as represented by OAT-bund spreads) that it’s ever been (i.e. relative French sovereign risk is driving € IG CDS index spreads more so than ever), but Euro IG credit is still woefully disconnected from the very same political risk that’s caused that very same correlation to rise.
It would be like consciously adjusting the speed at which you’re driving commensurate with the number of shots you had at the bar, but still driving 96 miles per hour. You know your speed should be correlated (in this case negatively) with the number of shots you’ve had, but somehow knowing that only causes you to reduce your speed from 100 to 96 instead of from 96 to say 50.
So consider that, and then consider this out Friday afternoon from Goldman:
Given the degree of compression and now tight valuations in EUR HY relative to IG, we are downgrading EUR HY to underweight vs. IG. We also believe EUR IG credit is better positioned than HY in the current environment where political uncertainty persists in the busy election cycle, similar to our expectation for IG credit to outperform HY in the US where the policy outlook is also uncertain.
So just try and wrap your mind around all of this.
We’ve got Goldman telling us that € HY has done so well versus € IG that it’s time to favor € IG, but that very same € IG is comprised of 23% French debt and € IG spreads haven’t even begun to price in the very same French political risk that’s causing the correlation between iTraxx Main and OAT-bund spreads to soar to 92%.
And somehow, out of that, we’re supposed to think that € IG is a relative bargain, because € HY is itself far too rich.