We were wondering which sell-side desk would be the first to comment on Tuesday’s market mayhem and minutes ago we got our answer from BofAML’s credit team.
And while JPMorgan’s quant Gandalf Marko Kolanovic contends that Tuesday was not in fact about politics, it’s difficult to ignore the fraught political backdrop against which today’s bloodbath was set.
With that in mind, consider the following brief commentary.
One of the big questions this year has been whether equity market euphoria or bond market skepticism (Figure 1) reflected the correct read on US policy risks with the new administration. With difficult negotiations on health care reform delaying tax reform equities finally blinked. It is not yet clear whether this warrants a tactically more defensive stance on credit. But volatility should be higher and we should see more days like this.
As we pointed out in Equities not rates, a correction in stocks following the large rally since the US elections is the biggest near term risk to high grade spreads. The leading scenario that could trigger such a correction is a rise in US policy risks, particularly related to the tax reform. Today’s 1.2% decline in S&P 500, led by banks (-3.9% on KBW Bank Index) illustrates this scenario. As our economists highlight, the continued uncertainty about the timing of ACA (Affordable Care Act) reform increases the chance that other items on the reform agenda get delayed as well. An accompanying decline in interest rates, highlighted by today’s 8bps intraday drop in 10- year Treasury yields, could amplify the negative impact on spreads.