High Yield

With oil prices pushing cycle lows and Shale firms as loaded with debt as they have ever been, the spike in energy sector credit risk should come as no surprise as the hopes of the last few months are destroyed. At 1076bps, credit risk for the energy sector has never been higher. As UBS recently warned, more defaults are looming and, as we discussed this week, private equity is waiting to pick up the heavily discounted pieces.

Offshore Yuan continues to trade at a discount to onshore against the USD (imply a modest further devaluation is due) but the spread is narrowing and today's practically unch Yuan fix is dragging USDCNH lower (stronger Yuan). Yesterday's afternoon session ramp in stocks managed to extend its gains as margin debt rises for the 7th straight day. The PBOC injects 120 bn Yuan liquidity via 7-day reverse-repo (notably more than the 50bn maturing), as HSBC's Stephen King concludes, the message from last week's surprise devaluation is clear - China no longer wants to play the "global shock absorber" role - instead is more focused on domestic instability... and there is no other nation yet willing (or able) to shoulder the responsibility.

“The way to wealth in a bull market is debt. The way to oblivion in a bear market is also debt, and nobody rings a bell.” – James Grant

"Time is now rapidly running out," warns The Telegraph's John Ficenec as the British paper takes a deep dive into the dark realities behind the mainstream media headlines continued faith in central planning. Sounding very "Zero Hedge", Ficenec warns that from China to Brazil, the central banks have lost control and at the same time the global economy is grinding to a halt. It is only a matter of time before stock markets collapse under the weight of their lofty expectations and record valuations.

Just two days ago we warned of the dramatic disconnect between equity insurance and credit insurance markets - at levels last seen before Bear Stearns collapse. As the Yuan devaluation shuddered EURCNH carry traders and battered European assets, US equity markets stumbled onwards and upwards, impregnable in their fortitude with The Fed at their back no matter what. However, US corporate bond markets were a bloodbath...

It is what happened in investment grade fund flows in the latest week that is making CEO, especially those whose compensation is a direct function of how much stock they repurchase, very nervous because as Lipper reported overnight IG funds just saw $1.8 billion in outflows, the most in over two years or since June 2013. And without the fund inflow train into IG funds operating smoothly, suddenly stock buybacks appear in jeopardy...

After a week of relentless FX volatility, spilling over out of China and into all other countries, and asset products, it was as if the market decided to take a time-out overnight, assisted by the PBOC which after three days of record devaluations finally revalued the Yuan stronger fractionally by 0.05% to 6.3975. And then, as a parting gift perhaps, just as the market was about to close again, the Chinese central bank intervened sending the Onshore Yuan, spiking to a level of 6.3912 as of this writing, notably stronger than the official fixing for the second day in a row. In fact the biggest news out of China overnight is that contrary to expectations, the PBOC once again "added" to its gold holdings, boosting its official gold by 610,000 ounces, or 19 tons, to 1,677 tones.

“Maybe this isn’t a great indication of the state of the economy.”

With everyone now focused on what China's daily Yuan fixing will be ever night, there was some confusion why last night the PBOC decided to devalue the CNY by another 1.1% to 6.4010, despite its promise that the devaluation would be a "one-off" event, taking the 3 day devaluation to just about 4.5%. However, subsequently in a press conference, central bank vice-governor Yi Gang said that the PBoC will continue to step in when the market is ‘distorted’, that there is no economic basis for the Yuan to fall continuously and that it will look to keep the exchange rate ‘basically stable’. The Vice-Governor also said that the PBoC will closely monitor cross-border capital flows and that reports suggesting the Central Banks wants to see the currency depreciate 10% are ‘groundless’. Which is ironic considering after just 3 days, the PBOC is already half the way there!

As far as credit markets are concerned, U.S. stock investors have lost touch with reality.

The overnight market has been a repeat of yesterday's action, when following China's repeat 1.6% devaluation of the CNY (which was to be expected since the PBOC made it quite clear the fixing would be based off the market value, a value which continues plunging), the second biggest in history following Monday's 1.9% plunge, traders appeared stunned having believed the PBOC's lies that the devaluation was a one-off and as a result the E-Mini tumbled overnight, and is now 30 points lower from last night's PBOC fixing announcement, trading at around 2058, and far below the "magical" 200-DMA support line, which has now been solidly breached.

If yesterday it was the turn of the upside stop hunting algos to crush anyone who was even modestly bearishly positioned in what ended up being the biggest short squeeze of 2015, then today it is the downside trailing stops that are about to be taken out in what remains the most vicious rangebound market in years, in the aftermath of the Chinese currency devaluation which weakened the CNY reference rate against the USD by the most on record, in what some have said was an attempt by China to spark its flailing SDR inclusion chances, but what was really a long overdue reaction by an exporter country having pegged to the strongest currency in the world in the past year.

Wondering why stocks are surging this morning - aside from Fischer's comments, OPEC rumors, Greek bank recaps, and JPY ignition? Perhaps it is the veritable swarm of professional technical analysts out with notes warning of significant problems ahead. From John Hussman's refined Hindenberg Omen and Carter Worth's "sell stocks, breadth is a problem," to Oppenheimer's warning of "seasonals and weak internals," and Louise Yamada's "stocks are vulnerable, keep cash on sidelines" warning - it appears today's early bounce is as much about contrarian oversold bounce as it is about any macro news. But with 73% of the largest 1000 stocks at least 5% off their highs, stocks remain fragile as they push back towards highs.

Following last week's bad news for the economy (terrible ADP private payrolls, confirmed by a miss in the NFP) which also resulted in bad news for the market which suffered its worst week in years, many were focused on how the market would react to the latest battery of terrible economic news out of China which as we observed over the weekend reported abysmal trade data, and the worst plunge in Chinese factory prices in 6 years. We now know: the Shanghai Composite soared by 5%, rising to 3,928 and approaching the key 4000 level because the ongoing economic collapse led Pavlov's dog to believe that much more easing is coming from the country which as we showed last night has literally thrown the kitchen sink at stabilizing the plunge in stocks.

In a month in which the Establishment survey reported that 215K jobs were added, the Household survey was far less sanguine, estimating only 101K job gains in June after a drop of 56K in May. But the punchline emerged when looking at the age composition of the job winners... and losers. As we expected, more than all job gains, or 211,000 of the total, came in the 55 and over job category. Workers 16-24 lost a total of 8,000 jobs. And the worst hit were, who else, those in their prime, as the number of workers aged 25-54 dropped by another 131K.