Deutsche Bank’s annual study of defaults has landed. Thoughts on how the next cycle for corporate borrowers might be affected by flatter yields curves below, but first a reminder of just how little money has been lost to bad debts since 2009.
We can’t overstate how low overall defaults are. The 2010- 2014 cohort is the lowest 5-year period for HY defaults in modern history (quality adjusted). To protect for default risk in BB and Single-B rated bonds over this period, investors would have only required 27bps and 94bps respectively. Current EUR/USD BB spreads are 301/350bps and Single-Bs 598/527bps. Indeed in CDS, Crossover now has 10 full years of default history. The peak 5 year default period was the 12% seen in Series 8-10 (late 2007 to late 2013). Relative to its ratings, average default risk for this index should now be around 20%. So this reiterates that recent history and average history in default terms remain remarkably far apart.
Rhetorical question, just to share this chart from Dominik Winnicki and team at Barclays (click to enlarge)…
Is that the calming fragrance of sanguinity? Perhaps. Lets return to the bond market and the state of answers to the question: what will happen if, when, maybe, interest rates go up instead of down.
The fear, simply put, is that at some point there will be an awful lot of sellers of bonds, and very few natural buyers. For the corporate bond market in particular, banks don’t hold as many bonds as they used to, and can’t take the sort of risks that buying big piles of bonds when everyone else is selling would imply.
If you are in a job, say manager of a bond mutual fund, where you have to give customers their money when they ask for it, this might make you nervous. If when maybe that day comes. Read more
Over in Mac McQuown’s Sonoma Valley workshop, courtesy of Bloomberg Markets…
McQuown says his eBond will enable investors to jettison their credit risk because the swap, which is essentially a form of insurance, will cover their losses should the debtor fail. To garner such protection now, an investor must purchase a swap separately to cover a bond. Read more
Could the real cause of today’s financial malaise have less to do with greedy bankers, bad regulation and poor monetary policy, and more to do with the effects of the information technology age on banking?
That at least is the argument proposed in a new book, “The end of banking – money, credit and the digital revolution” by Jonathan McMillan, a collective pseudonym for two authors who are keeping their identities secret, but who hail from the world of banking and academia.
Not to say the financial system was free of instability before the IT age, it’s just that the way in which the instability was dealt with was entirely different. Read more
Who doesn’t like to start the day with a nice hot cup of vindication? There will be plenty of time to recognise those who have been warning about a lack of real liquidity and the chance of real volatility later. For now the question is what to do?
Credit strategist Alberto Gallo of RBS, who has been on team no-liquidity for a while, says wait and see.
What do we do now? We wait a bit longer. Our high yield macro-spread model shows cash should trade at around 500bp in € vs 400bp currently. European high yield spreads are still below last year’s tantrum levels, while US HY spreads are just getting there (508bp). Compared to previous bull market selloffs, this isn’t a short one – but could still last for a while longer.