While everyone is watching the absolute spread levels of high-yield bonds (or their prices or all-in yields) as the recognition of broad-based default risk (contagiously carried over from bloated and levered energy firms) arrives at the mainstream. However, under the surface of the arcane world of credit derivative indices is 'the basis' - which measures the difference between the index level being traded and the implied level of the index based on the individual components. In English, the basis measures the relative demand for macro risk protection... and it's at its highest since the chaos of Summer 2012...
The high-yield credit market is flashing very red... (as the HYCDX 'basis' suggests managers demand for protection is very high)
[3]
While equity index products and their underlying components are arbitraged in almost infinitessimally small increments so that, for example, the S&P 500 ETF and the 500 components that 'trade' as its portolio are all kept in sync; in credit markets, due to differences in liquidity, technicals (flow), and demand, the index and its underlying components can (and do) trade apart.
* * *
In the case of the High-Yield credit market, investors are willing to pay over 30bps more for protection than is 'fair' to ensure some liquidity and insure positions... this is an extreme amount of fear that is not priced in any other markets (yet).
