Equity markets haven’t yet managed to shake off their difficulties. If this selloff persists, credit looks like it could well be the next frontier for trouble.
You can’t have falling stocks and tightening credit spreads — it doesn’t make sense to have risk-off sentiment prevail in an incredibly liquid market alongside a risk-on approach in an illiquid one.
Arguably it is good to take a breather when all hell is breaking loose — in fact, it’s written into prospectuses of new deals, with the small print that they’ll issue “subject to market conditions.” Europe’s newly issued corporate bonds are nevertheless showing the strain.
A rethink was well overdue, given that spreads had contracted to incredibly optimistic levels. As Gadfly argued that risk managers should be looking carefully at their value-at-risk models. They should equally be asking searching questions about overexposure to risky credit.
Spreads are also vulnerable to changing sentiment in government debt markets. Last week, fears about rising inflation drove Treasury yields higher. This week is seeing a bull steepening in the yield curve to grab the safety of two-year yields. A natural companion to this is wider spreads.
The market turmoil has also dented the new issue market. Greece is now waiting for the “right moment” for its next euro-denominated bond issue, instead of coming on Tuesday with a seven-year deal. A tweak to its timetable ought not to derail its recovery plan. Likewise some high-yield deals might choose more opportune timing. Not all new issues will be lost in the wilderness. A AAA-rated credit such as a new issue from Finland, or a U.K inflation-linked deal, can get away with nary a scratch.
As with short-volatility trades, it’s hard to know if everyone’s worked out what they’ve missed and plugged their gaps. For now, conditions are rockier for corporate credit, and it makes sense for issuers and investors to wait until the bloodletting subsides.