Credit Closes at Lows As Equity Ends At Highs

Investment grade and high yield credit spread markets, which typically trade very closely coupled with equities, followed the path of the European session and completely negatively diverged from stocks today. IG and HY credit closed very close to its wides of the day while the S&P managed to limp up on average volume to close near the day's highs - after stagnating around VWAP for much of the afternoon. Into the close, we saw a similar pattern to yesterday as hedgers jumped in to credit and HYG (the high-yield ETF) dropped significantly and IG credit (a cheap hedge) lost ground. ES tracked risk markets (outside of credit) almost perfectly all day long - something we haven't seen in a few days - as today appeared very much a wait-and-see day with Europe's modest outperformance enough to quench sellers in equity positions for today at least. Commodities (ex-Oil) were largely unchanged as the dollar ended modestly lower as EURUSD oscillated on Merkel rumors and correlation trades. TSYs rallied off what was an awful 30Y auction but ended the day higher in yield and steeper in curve.

Given the detail in the chart we suggest you click to enlarge it. From earlier in the week, equities appear to have been clinging to hope while professionals in the credit markets have been derisking. HY has faced some stress from two BK (or near BKs) but today's action is as divergent as we have seen in days with IG and HY (dark and light red) closing near their lows of the day as stocks (blue) end near their best levels. Also note the late day dive in HYG (green) as it dived to catch up to HY's performance - this is once again related to the liquidity preference as longs obviously concerned about holding overnight reached for whatever was easiest to hedge.


The moves in equity markets - specifically the S&P 500 futures - were extraordinarily correlated with risk assets today. As we often say, if you can see EURUSD then all is clear. But today the chart below, which can be tracked intraday here, shows the broad risk-basket and ES were keeping each other company all day suggesting little 'exogenous' buying or selling pressure from real money.

Away from our normal charts, we note that the cross-currency basis swap for EURUSD has reached levels not seen since 2008. This tends to be a decent proxy for the funding stresses between USD and EUR denominated markets and suggests the seriousness of the bank funding markets that perhaps Libor (with its central bank disintermediation) does not always transparently indicate.

and EUR-USD swap spreads indicate - at least for now - that EURUSD has reached a model-based 'fair-value'. Based on the full term structure of swap spread differentials between the USD and EUR, this chart gives some sense for the drop in the EUR that we have highlighted caused the short-squeeze, the over-correction spike and the settling back to 'nromal' for now. Of course, with Greek, Italian, French, and Austrian bond spreads all breaking records (and EFSF bonds deteriorating rapidly), the growing expectation that the ECB will print-and-rescue is perhaps weighing (among other things) on the FX market.

All-in-all, it is incredible to us that we can see such divergences among the major asset classes - especially given HY's still extreme cheapness to equities (if one had a bullish perspective). Under the covers, chaos is reigning and relying on good-old-fashioned Dow indications is clearly not enough to manage risk in this environment - though we hope that has been obvious for years.

Charts: Bloomberg