I see no evil in the bond market

good morning.on friday i I have written “If the jobs report significantly beats the consensus forecast of 195,000 new jobs, the market could be a little turbulent,” he said. The number reached 339,000 and the market panicked. upwards. The S&P rose 1.5%, its biggest daily gain since April. Perhaps yesterday’s debt ceiling deal was more important to investors than the threat of another rate hike? Perhaps the market has taken some comfort from the drop in hourly wages along with a significant downward revision to the wages component of Q1 GDP?could have been weak positioningOr maybe Mr. Armstrong was simply misunderstood. In either case, please send an email to robert.armstrong@ft.com.

Subprime Auto Debt and Junk Junk Bonds

Similar to Unhedged, It pointed out Something is wrong with the low-end US consumer these days. And if the problem escalates, it seems likely that it will spread to auto loans as well. Auto loans are the type of debt many low-income deciles Americans are forced to take on. The closest thing we have found to timely data on subprime auto debt is his 60-day delinquencies index for subprime auto-backed securities rated by Fitch. Here are the numbers through April:

Currently, delinquencies are hovering at their pre-pandemic highs, and the trend is increasing sharply. Jen Thomas, a portfolio manager at Loomis Sails and a favorite consumer debt expert at Unhedged, said the subprime auto stress was on loans executed in more recent vintages, namely 2020 and 2021. I say that I am concentrating.

This trend has improved a bit in recent times, as borrowers who suffered the worst during these times did not repay their loans and were excluded from the underlying loan pools of asset-backed securities. Instead of defaults reaching recessionary levels, Mr. Thomas says borrowers are “playing the game again” — falling into early delinquency but paying just enough to avoid foreclosure. He said he was witnessing things like that. But demand for subprime automotive ABS remains very strong, she said. “She can’t help but like the two-year yield above 5%.”

We will continue to monitor the number of overdue cases. On the other hand, is the same thing happening with the lowest quality corporate bonds? Well, maybe — just. Bank of America’s Oleg Merentiev said 10 U.S. high-yield issuers defaulted on $7.2 billion in bonds in May, with an annualized default rate of 7.3%, up from a default rate of 2.3% over the past year. reported a notable acceleration (7.3% annualized default rate, according to Moody’s). He had 20 defaults in the entire first quarter). Here’s a graph of default rates through the end of March, produced by Merenchev’s team. Notice that the ex-Energy default rate (brown line) is still below he 2016 to he 2018 levels.

Merenchev also pointed out that the yield spread — defined by high yields as the percentage of bonds trading more than 4 percentage points off the benchmark index yield — has risen. More than 50% of CCC (the riskiest junk) bonds are currently trading at wide deviations from the index, with a low of less than 20% in 2021. The market is increasingly distinguishing between “good junk” and “bad junk”. Finally, recovery — the amount a bondholder would receive in the event of default — is about 30 cents on the dollar, a “close to historically low” level.

Are markets reacting to these stress signals by demanding bigger discounts to hold the riskiest debt? Bloomberg reported: global baseit is:

The riskiest corporate bonds have tumbled amid growing signs of an economic downturn, fueling fears of further defaults and distress.

Debt at the bottom of the junk, CCC-rated companies, fell the most in eight months, driven by a 23% plunge in Chinese government bonds in May. With the economies of Europe, China and the United States faltering, pressures from rising interest costs, falling earnings and reduced access to capital are expected to continue.

“Buying CCC now is playing with fire,” said Hunter Hayes, portfolio manager at the Intrepid Income Fund.

Emphasize this no But it’s happening in the US. CCC spreads on US government bonds have tightened in the past few months. Moreover, the spread gap between U.S. CCC bonds and single B (lower risk junk) and BBB (lowest investment grade) bonds has narrowed since the end of last year. In other words, the premium for holding the riskiest U.S. government bonds is shrinking.

The U.S. corporate bond market doesn’t appear to be pricing in much recession risk. As my colleague Harriet Klarfeld notes, this may be due to the lack of supply of bonds to the market. written. Merenchev believes the current stalled market is partly because “the good stocks are already tight” in the highly diversified junk bond market. [expensive]and difficult ones are not bid. Nonetheless, the pattern of prices holding firm while fundamentals weakening on margins is similar to what we see in the stock market. There is risk appetite.

european shadow bank

Unhedged is usually focused squarely on the United States. But even for US investors, the financial stability of the European Central Bank is not important. reportespecially the section on shadow banking risks, is worth reading.

The basic points made in this report are well known enough. Non-bank financial institutions such as investment funds, pension funds, money market funds and insurance companies are growing much faster than banks. Shadow banks, in particular, have increased their exposure to illiquid assets such as real estate during periods of low interest rates, and may face withdrawal and liquidity shortages when interest rates rise.

Importantly, the report notes that there are significant links between the non-bank financial system and banks, with the former owning much of the latter’s non-deposit liabilities, including nearly all of the convertible bonds of European banks. pointed out. “A significant outflow of funds from such investment funds could trigger the sale of securities issued by banks and other financial institutions. This would amplify the negative impact of price pressure on bank funding markets. There is a possibility.”

Risk is not theoretical. We are already witnessing a micro-crisis in which a combination of leverage and illiquidity in non-bank institutions is causing tremors in broader markets. The ECB provides the following handy chart that acts as a sort of glossary of how things can go wrong.

Absolute Strategy Research’s Ian Harnett was kind enough to point out to me over the weekend about the ECB’s report that the post-crisis increase in financial asset holdings has essentially all happened outside the banking system. pointed out. Non-banks now hold more than half of the eurozone’s financial assets. This makes the ECB report, in his words, “difficult to read.” The next European financial turmoil is unlikely to start with banks.

well read book

Germans eat a lot less sausage.