Market Snapshot: Credit Early, Financials Unch, And New Issues Ugly

Following the FT's news that (totally un-shockingly) there is disagreement among European member countries over pretty much everything, equities (and broader risk assets) rolled over and accelerated to the downside. We had been pointing to the early weakness in credit markets (especially European financials) as a signal that the rumors were made of nothing and that the rally in equities was starting to get ahead of itself - having been jump-started yesterday by a small cap short-squeeze (and potentially some asset allocation decisions which may have also impacted equities)but the velocity of the retracement was still surprising. The S&P lost 30pts from its highs, HY ended wider on the day (risk appetite seems low given new issue concessions) and financials in the US managed a small bounce off unchanged right before the close after giving up over 3%.

It was very evident that credit markets were talking a different (and notably less bullish) story from early in the US day (middle of the European day) and that selling pressure continued all day - despite some technicals due to the roll in the HY credit index today. On that topic, we suspect yesterday's rather strange action in HYG was related to hedging this roll in HY CDX since today's selling pressure was acute in the old index suggesting credit longs were more adamant to roll - though suffering today.

Credit had a few other surprises today with JPM ending the day 3bps wider (the only major to lose ground close to close) while the rest were all notably off their tights of the day. HY curves flattened in general (though tightened) but liquidity was focused in the index where HY16 saw 3Y +13 and 5Y +7bps on the day. IG17 crept into the red after the close at 136.625bps (+0.125bps) - even as single-names compressed around 5bps (which was very much skew compression technicals). So a mixed bag overall hindered by technicals from the HY roll but tough to find too much to be positive about.

There was some positive chatter about the fact that a few new issues were well received today in corporate bond land. It is true that not only did MCD (a solid high quality name) but a few much uglier companies in the HY space managed to deals off including HCA and Qwest. We looked into them a little as we were modestly surprised by the reception/demand. The MCD deal was issued at a very reasonable T+78bps - almost perfectly in line with where CDS markets would price the deal suggesting demand was driven by real money investors looking to put money to work in a quality name (since concessions were low).

However, and we bring this modestly complex topic up as it relates to risk appetites in general,  a new issue from the HY market was placed at a huge concession to the CDS market. If a new issue were to come to market at an extremely high yield (low price) relative to current market conditions (secondary bonds or CDS spreads) then it is very attractive - but obviously the issuer does not want to pay too much to issue debt. If the difference between issue price and existing credit market prices is large (and negative) then it strongly suggests that the issuer needed to sweeten the pot to encourage buyers to lend them money.

Today as we see above the Qwest deal came at an enormous concession to CDS expected value (Model Price in lower left of chart - which was around $108!). This means any active fixed income hedge fund will be drooling to pick up the bond and asset swap it for the basis - buy bond (lend for new issue) and buy credit protection (short credit synthetically) to bank (almost risk-free) the price/spread differential. It seems given the concession that very few real money buyers were interested and they had to rely on the hedgies and basis traders (who demanded their pound of flesh).

We bring this nuance up as we have discussed the fact that HY funding is under stress, HY bond volumes are not great and very gappy, and when we see new issues pricing with such concessions it will cause secondary bonds to reprice to this new level (as opposed to the mark-to-myth levels an illiquid market can withstand. We will continue to watch new issue concessions as a signal for demand (healthy or not) to help confirm whether risk appetite is really emerging or rallies are still to be faded.

On the topic of faded rallies, today's dramatic sell-off in stocks was led by Financials (which dropped over 3% from their peaks around 1421ET before a small bounce into the close. Energy and Materials were also big losers in that sell-off while Utilities and Staples held in.

In general, strength in stocks had been supported by a quite significant retracement in TSYs (and rise in 2s10s30s) as well as a notable rise in EURJPY (as well as AUDJPY and most of the JPY carry crosses). Whether this was led by stocks (as carry was levered) or was leading on a squeeze of JPY longs is unclear though JPY was the only major that weakened against the USD today. EURUSD lost 1.36 into the close and is holding below that currently.

TSYs have retraced all the rally post-Bernanke, and then some, in all but 30Y. 30Y remains around 13bps lower in yield (and the curve flatter overall) but 2s, 5s, 7s, and 10s are all higher in yield now than before Bernanke pivoted. Its also worth noting that the 2s10s30s butterfly has risen from 42bps to highs over 67bps this afternoon since yesterday's low print right before the US open - certainly another carry-driver for US equities and we note it lost 4bps into the close.

Precious metals largely trod water during the US day session after recovering most of their losses from Monday. Oil is the modest outperformer from Friday's close, followed by Copper (both around 4%) and while Silver was off its highs this morning it remains +2.5% from Friday as Gold hovers close to unchanged around $1650 (about 7% above Monday's lows).

The sell-off in stocks was actually significantly overdone relative to the moves in other risk assets today but in context the rally was also advancing much more so than the broad risk basket would suggest so over a span of a few days we are much closer to fair-value than a single-day would suggest.


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