The message of the market has been very clear the last week or two and we have been actively discussing it - the hope that was priced into equity markets is being discounted back to the reality that was always priced into credit markets. HYG, increasingly liquid, accessible, and actively traded has become the weapon of choice for hedgers and shorts and once again today it dramatically underperformed. IG credit also underperformed as we suspect the relatively low cost of carry made it an attractive macro-overlay into a long weekend of possibilities. Commodities in general converged back on the inverse of the USD performance of the week, down around 1.5% (with the exception of Copper which is -4% on the week as China hopes fade). Equity weakness was generally supported to the downside by CONTEXT's broad basket of risk assets - especially as TSYs rallied aggressively in the afternoon following the record 7Y auction. AUD remained the ugly duckling of the week in FX land (as carry was unwound) but EUR's slide was the biggest driver of DXY's strength as it gained around 1.3%. Evidently very few wanted to go home long into this weekend and ES dumped into the close ending the week -4.5% or so with a major volume surge at the very end.
This week has seen day after day of heavier and heavier selling pressure in HYG as we suspect the virtuous circle of forcing creation units to buy secondary bonds is being unwound in a hurry (discussed here and here more specifically). As we perfectly described would happen in this post on 10/24, HYG's underperformance relative to HY spreads and more importantly stocks was mirroring the surges we saw on the way up as the ETF was stuffed. To get a sense of the 230bps underperformance on the day (which ended 160bps with the rapid sell-off into the close), we use the SPY Arb model (which can be tracked in real-time here) to account for the non-linearities and empirical relationship - the point is - this was a major move in HYG and we have only seen the start of the redemption of shares outstanding in this ETF. Keeping an eye on secondary HY bond volumes, advance-decline, and pricing will be critical in the next few days.
Today's significant underperformance of IG also suggests hedging was a big driver of risk concerns (and the PMI filing likely meant the need to hedge with whatever was liquid in credit derivative markets probably exaggerated the move).
HYG's dramatic sell-off the last few days has caught it up to HY credit spread performance very rapidly and for the first time in over 4 months, shares outstanding are starting to drop. This is very worrisome, redemptions in this fund that we have noted before has been channel-stuffed with any and every HY bond that professionals couldn't (and wouldn't) offload into the secondary markets for fear of setting off avalanches, is about to be forced to sell into that very market.
Copper was adrift in disappointment as the rest of the commodity complex seemed to gravitate to the USD move this week.
TSYs rallied aggressivley after inching into the red early on in the day and notably 2s10s30s dropped like a stone as selling pressure escalated into the afternoon.