This Is The “Most Vulnerable” Index In Credit To Macro Risk

Well, this was pretty easy to see coming.

Early last month, we said the following about high yield in an environment in which both the demise of retail and oil prices are headwinds:

Amid questions about commodities, HY investors don’t really need another reason to think that what they’re holding is too rich. Or, put differently, that a decompression episode on the order of the mammoth spread compression we’ve seen over the last 14 months is in the cards.

Given that, this chart is unnerving:


See why that’s bad? It feels a lot like when US energy producers lost market access. 

The extent to which HY is in peril from both retail and energy was the subject of a Goldman note that came out around the time we wrote the passages excerpted above.

Goldman’s argument was that “the technical spillover and scope for any impact to the broader HY market [from HY retail] will be more limited than HY Energy in the late 2015/early 2016 paradigm.” They highlighted several reasons for their contention and you can read the full rationale here.

Well needless to say, the dour outlook for retail hasn’t changed since last month and the outlook for energy has deteriorated meaningfully. That gets us right back to the point raised here at the outset, which is what the fuck is HY going to do when the space comes under pressure from spread decompression in two components at once?

As it turns out, this dynamic is more relevant for synthetic than cash. Here, courtesy of BofAML, is why:

Energy exposure in credit and the ‘return’ of CDX HY

The HY cash universe continues to have the highest exposure to the Energy sector. In contrast, rating downgrades have substantially reduced the proportion of Energy names in HG. Another notable issue is the behaviour of CDX HY, which now has several oil related names in the portfolio. This has meant a decompression in HY vs. IG spreads with lower oil prices.

Interestingly, unlike its cash counterpart, CDX HY also has high exposure to Retail names. Quite in contrast to the past couple of years, this index now appears to be the most vulnerable to macro risks compared to other benchmarks in credit.

The CDS-cash basis for Energy names is positive i.e. the former is cheaper. Together, this is indicative of the high bar there is to sell bonds here. Rather, the preference has been to either hedge with or short CDS.


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