The last few weeks have been characterized by considerable inflows into European credit. With spreads so tight and total returns mediocre in ‘17, it may seem like a shortterm aberration. But we think it is anything but. We think these are structural inflows coming from both households and corporates who are increasingly frustrated with the declining rates of return from bank deposits. Thus, this credit buying wave has to be seen as the ultimate affirmation that Draghi’s unconventional negative interest rate policy (NIRP) has succeeded. The “lust for return” is alive and kicking.
That’s from BofAML’s incomparable Barnaby Martin and it underscores what we’ve been desperately trying to explain about the effect QE has in terms of driving investors down the quality ladder in search of yield.
The reason you’re seeing a continued grind towards post-crisis tights in IG and HY credit is that central banks are simply creating artificial demand by engineering a never-ending quest for any semblance of yield.
In Europe, the outright purchase of corporate credit has created an overwhelming technical and as Citi’s Joseph Faith and Matt King explained in a note out Monday, the ECB has managed to replicate the pre-crisis environment wherein the proliferation of synthetic CDOs effectively created negative net supply.
Well as we’ve also been keen to remind you, the end result of all of this is that investors get driven further and further down the quality ladder until eventually, people who used to be satisfied with risk-free govies look up and find themselves doing weird shit like chasing after junk offerings and fracker IPOs.
Or weird shit like driving yields on € HY (nearly) lower than the yield on US Treasurys.
And yes, you read that right.
Here’s the above mentioned Barnaby Martin:
Is Euro High-Yield the new US Treasury market?
Inflow waves mean bubbles…and bubbles mean tight spreads. Perhaps no better example of this is the rapid price appreciation in Euro high-yield bond prices lately. In less than a month, Euro HY yields have declined (another) 55bp, reaching an all-time low of just 2.3%.
In fact as Chart 7 shows, European HY yields have almost declined to the yield on BofAML’s US Treasury index. And while there are indeed duration differences between the two markets, it doesn’t detract from the eye-watering levels that European high-yield has now reached (albeit helped along by improving leverage metrics and ratings upgrades).
Slicing and dicing the Euro HY index, we find that there are plenty of sub-investment grade rated bonds that yield less than equivalent-maturity US Treasuries.
Chart 8 shows that over 60% of European HY senior BB now yield less than equivalent maturity Treasuries.
And Chart 10 adds, perhaps, a little bit of irony to the low yield credit backdrop in Europe: we find that around €23bn of Italian Euro BBs also yield less than equivalent-maturity US Treasuries.
Let’s go to Jeff Gundlach for some hard “truths“…
The yield-to-worst on the European High Yield Index is only 10 basis points above the yield-to-maturity on the Ten Year UST. Wack-o season!
— Jeffrey Gundlach (@TruthGundlach) August 8, 2017
Now if only he knew how to spell “whack.”