The stress in junk bonds is all about oil

The biggest source of fascination and anxiety among investors to start 2016 was the high-yield bond market.

The main sign that something was wrong was the blowout in credit spreads — meaning the difference between the yield in bonds with a “junk” rating and Treasury securities of the same maturity increased dramatically — leading investors to take this as a sign that something is wrong not only in financial markets but perhaps the global economy.

The counter to this argument is that the stress in high-yield was and remains mostly focused on the energy sector.

And this chart from Deutsche Bank would seem to back up the latter view.

In a note to clients on Thursday, John Tierney at Deutsche Bank wrote (emphasis ours):

This time around, things are a bit different in that spreads have widened on account of macro concerns combined with genuinely higher defaults in the energy and materials sectors. Investors must distinguish these two issues. Sure, macro concerns do keep mounting — prominent on the radar recently are US growth slowdown, China devaluation fears, slumping commodity prices, health of emerging market economies, European banks, the shift to negative interest rates and Brexit. But the view on the broader high-yield market should have very little to do with the commodity cycle or the longevity of the recovery. Rather, it should have everything to do with whether one believes policymakers will keep muddling through or if they are about to make an error that plunges the global economy into another 2008-09 crash.

Said another way, when you’ve got a chart showing commodity-related (read: oil) defaults flying through the roof, spreads rising across the high-yield complex probably don’t mean what those extrapolating about broader macro fears think they do.

Or as Tierney wrote, “To summarize, looking at the market rationally, there is little reason to suppose that the broader high yield market is on the verge of another epic default cycle.”

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