Heisenberg Report

Are Junk ETFs About To Get Stress Tested As High Yield Cracks?

Guess what?

Junk is starting to roll over and do you know what that (might) mean? That might mean that we’re not too far away from that underlying liquidity mismatch in the high yield ETFs getting a stress test.

As we noted on multiple occasions this week, HYG and JNK are looking mighty shaky:

Just to be clear, HYG had its worst day in more than a year on Thursday and if things don’t improve, Friday is going to be even worse. Not helping matters is crude, which is in a dive and has fallen back below $60 for the first time since December:

The outflows from HY funds are starting to pile up. “Outflows from high yield have accelerated in response to the weak secondary environment, with retail funds and ETFs losing $2.4bn over the last week alone (-$1bn HY ETFs, -$1.4bn open-end),” BofAML writes, in a note dated Friday. “On a trailing 4 week basis, US HY funds have lost $5.6bn (- 2.4%), the most since March 2017,” the bank continues.

Long story short, this is starting to spill over into credit and as we wrote in “Harry“, that is not a good sign. Have a look at CDX spreads:

So for right now, this is being expressed in CDX and HYG/JNK – i.e. where the liquidity is.

But remember, at some point people will start selling the underlying and that’s when shit gets really messy, especially if that selling ends up being prompted by massive outflows from the ETFs whose holders have no conception whatsoever of the underlying liquidity mismatch.

“It’s all ETF-driven — it doesn’t feel like real money is selling, but it’s not buying either,” one portfolio manager told Bloomberg for a piece out Thursday. He added: “You could get into a short-term liquidity crunch and could see some disorder in our market. But until that happens, it’s not panic time.”

Right. So if you see the underlying bonds getting dumped, well then things will start to get interesting in hurry.