For the first time since the GFC, junk bonds (as a group) are officially “distressed”.
To be sure, credit markets have been “distressed” in a kind of general, anecdotal sense for weeks, but now we’ve breached the technical threshold beyond which we can all declare a high yield state of emergency.
On Friday, junk spreads breached 1,000bps, a level last seen in June of 2009.
It was the culmination of a harrowing week that found Goldman warning of a 24% contraction in the US economy in Q2 and Bridgewater sounding the alarm on a possible $4 trillion in losses for US corporates.
Downgrades and credit events are a certainty. The default cycle which has been forestalled for years by central bank largesse is likely upon us.
“A now weak and volatile US equity market helps to explain the lift-off by MA’s average high-yield expected default frequency metric from year-end 2019’s 4.18% to March’s 10.62%”, Moody’s said Thursday. “The high-yield EDF last broke above 10% in October 2008”, the ratings agency added, noting that “during the Great Recession, the month-long average of the high-yield EDF eventually crested at the 14.6% of February 2009”.
In IG, outflows in the week through Wednesday were quadruple the all-time record set just a week previous, Lipper said. The following visual (and this is discussed at some length in “Swan Song“) is astonishing, to say the least.
Over-leveraged corporate balance sheets are facing one of their most strenuous stress tests in history amid a near total shutdown of the US economy. It seems like just a matter of time before the Fed gets the authority to buy corporate bonds.
“The biggest thing that people are really worried about in the short term across the credit markets is there’s just been this massive rush for liquidity”, Wells Fargo’s head of credit strategy Winifred Cisar told Bloomberg’s Sarah Ponczek and Michael Regan this week. “It’s been the sell-everything strategy in the markets to raise cash, while issuers on the corporate side of things are drawing down revolvers, taking out their delayed-draw term loans, at basically a record pace”, Cisar added.
“Amongst several records recently, one that has stood out is the enormous outflow from bond funds at -$109 billion this week, bringing outflows over the last 3 weeks to almost -$150 billion”, Deutsche Bank wrote Friday. With the lone exception of short-term government bond funds, nearly every other category saw outflows, with credit (both IG and HY) suffering the most.
And, meanwhile, the elephant in the room is still the ETFs. The disconnects to NAV are wide.
You might be inclined to suggest that what you see in the following chart is just “price discovery” – that the ETF is providing a way for an illiquid market to be priced in real-time, just as some country-specific equity ETFs allow US investors to price foreign equities even when those markets are closed (e.g., for a non-US holiday).
But I would suggest that this isn’t “price discovery.” I’m not (necessarily) speaking directly to LQD here, but in a general sense, what you’re seeing is people tapping the ETFs for liquidity (e.g., to fund redemptions or raise cash).
The underlying market is, at least in some cases, no-bid.