From ZeroHedge, October 6:
Earlier this week, the euphoria over US high yield bonds hit new
post-crisis highs when amid a sharp slowdown in supply, a rise in the
oil price and generally solid economic conditions, insatiable buyers of
junk sent the Bloomberg Barclays Corporate high yield spread to the lowest since before the financial crisis, dropping as low as 303bps, the tightest level since late 2007 before drifting somewhat wider during the late week bond rout.
Yet while the US high yield market remains remarkably resilient in
the face of sharply higher yields, the same can not be said of European
junk bonds where the bubble may have finally burst.
As Bank of America's Barnaby Martin writes in his latest research
note, in stark contrast to shrinking US spreads, European high-yield
spreads have blown out by 70bp wider, with total returns just +13bp, a
far cry from the average annual returns of +11% observed over the last
decade. Putting this dramatic reversal in context, at the start
of the year Euro HY spreads were 80bp tighter than US spreads. Now they
are 35bp wider, in large part due to the deterioration in the Italian
backdrop, concerns about the end of the ECB's QE and the recent
deterioration in the European economy.
As Martin shows in the chart below, "one has to go back to late 2012
to find that last time that Euro HY spreads were this wide to US
spreads." Also note the variance in quality: 41% of the US HY market is
single-B versus just 24% in Europe.
What has prompted this curious reversal in the fates of the European
and US junk bond markets? According to Martin, a key theme for European
risk assets in general is that Quantitative Tightening by the Fed has
made simple "cash" in the US a competitive asset class again.
We think this dynamic is likely to weigh on European high-yield
spreads and also act as a barrier to meaningful retail inflows returning
in Europe.
This dynamic is laid out in the chart below, which shows the yield on European BBs versus the yield on US 6M Bills.
Martin highlights that bill yields have acted as a "lower bound" to
European high-yield spreads this year (the US Dollar has also been
rising since mid-April ’18). If that is the case, yields will only drift
wider as US cash rates become even more attractive as 3M USD Libor is
increasing again, and the Fed will likely hike rates at least another 3
rate hikes by the end of ‘19, to the detriment of the European
high-yield market....
Two other reasons for European junk bond weakness are the result of
composition, namely i) the high weighting of Italian names in Euro HY
(17%) and ii) the prevalence of credits with EM revenue exposure. As a
result of the current volatility in both of these
corners of the market, Martin believes that there will be even more
headwinds to Euro spreads. Chart 4 shows the implied impact of blowing
out Italian yields on European junk, while Chart 5 shows that Euro HY
spreads have had a reasonably high correlation to EM FX volatility over
the last few years (BofA's strategist also notes that the recent jump in
the US Dollar will likely lead to another round of EM currency weakness
shortly).
...
MUCH MORE
