Credit Canary Upends Hope Of Benign Bond Selloff

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by Tyler Durden
Tuesday, Feb 08, 2022 - 12:20 AM

Last night we warned that "Credit Market Cracks Could Spark Doom-Loop With Stocks", and today, Bloomberg's Cormac Mullen picks up a different angle in the ominous thread of cracking credit, writing that with the credit market showing increasing signs of stress, the chances of a disorderly rise in yields are piling further pressure on global risk assets.

Here are some more details from Mullen's latest Markets Live note:

A key measure of U.S. corporate credit risk reached the highest since September 2020 on Friday - and its European equivalent soared - after strong U.S. payrolls data and a hawkish ECB stoked expectations for aggressive rate hikes around the globe.

Unlike during last year’s Treasuries slump, when high-yield debt continued to push higher, this time junk bonds are selling off alongside their government equivalents -- witness the two popular iShares ETFs tracking the asset classes.

This credit weakness removes a key argument from bulls that risk assets can tolerate higher bond yields -- corporate debt is often used as a canary in the coal mine to detect broader market stress.

As always it is the pace of yield rises that poses the biggest threat to investors and last week they realized that the prospect of faster-than-expected central bank rate hikes is not just confined to the U.S.

Traders accelerated bets on ECB policy tightening to fight record inflation, when President Christine Lagarde declined to rule out a hike this year and the Bank of England came within a whisker of hiking rates by half a percentage point this month.

This spreading uncertainty over the speed of global rate hikes will have to be priced in to the upcoming slate of corporate bond issuance, coming in the midst of the ongoing earnings season. And if wage inflation continues to beat expectations, investors will have to adjust their expectations for corporate margins on top of accounting for rising borrowing costs in future refinancings.

Of course the hopeful demise of the omicron wave could brighten the economic picture and an alleviation in the supply-chain crisis could blunt inflation’s rise. But the fact that corporate bonds look to have joined the risk-asset slide is an ominous sign for global markets.