Junk Bond Spread Breakout

The famous dead parrot is coming back to life… in an unexpected place. With its QE operations, which included inter alia corporate bonds, the ECB has managed to suppress credit spreads in Europe to truly ludicrous levels. From there, the effect propagated through arbitrage to other developed markets. And yes, this does “support the economy” – mainly by triggering an avalanche of capital malinvestment and creating the associated boom conditions, while “investors” (we use the term loosely) pile into ridiculously overvalued bonds that will eventually saddle them with eye-watering losses.

 

The famous dead parrot

 

Readers may recall previous discussions of credit spreads in these pages –  on a whim we likened the demise of creditor suspicion to the dead Norwegian Blue in the Monty Python sketch. Credit is considered “suspicion asleep”, and the debate in the sketch revolves around whether the bird is merely sleeping or actually dead. Given what has occurred in credit spreads over the past two years, it is not too far-fetched to state that creditor suspicion appears to be dead rather than just asleep.

But we knew it would do the zombie thing and wake up again one day. We refer you to The Coming Resurrection of Polly and An Update on Polly for some background information. In the former we discussed inter alia how credit spreads have behaved in the past in the final stages of a boom and showed numerous charts illustrating what we believed to be quite important points; something traders and investors needed to file under “things to keep a close eye on”.

The points were a) the end comes very suddenly (and hence “unexpectedly”) every time and b) from a technical perspective, all it took on past occasions was a breakout in spreads above the nearest lateral resistance level. A small, barely noticeable breakout, followed by a successful retest – and suddenly spreads would take off into the blue yonder.

This is precisely what has just happened in euro-land, i.e., the global center of spread manipulation by a central planning agency. Behold a classic chart picture:

 

BofA/Merrill Lynch euro area high yield index spread (option-adjusted refers to the to the incorporation of early call options by issuers, which allow them to redeem bonds ahead of schedule). This is a picture-perfect breakout in junk bond spreads. Based on the  technical picture, this market is now a screaming short (n.b.: prices move inversely to yields).

 

Proceed with Caution Anyway

If you are pondering whether you should mortgage the farm, pimp grandma and sell your offspring into slavery to bolster your shorting wherewithal, hold your horses for a moment. As always there are caveats, despite the admittedly enticing technical imagery (coupled with the knowledge that corporate debt has been an accident waiting to happen for quite some time). We do see a potential opportunity here, but one should proceed with caution. Here is why.

Consider that the driving force behind the breakout was a political event, namely the recent election in Italy. We are of two minds about this trigger event. On the one hand, the effects of political news on market action are notorious for their fleeting nature. This is all the more relevant in euro-land, where the eurocracy has proved on numerous occasions that it is able to enforce its diktats, no matter how determined its opposition appears to be.

Just think back to the emasculation of  Syriza in Greece, or in the context of Italy, the palace coup that deposed the up until then untouchable Cavaliere, Uncle Silvio. Keep in mind that this was a man on whose behalf Italy’s legislature  passed laws that had no other purpose than to keep him out of legal trouble. And yet, it took the apparatchiks in Brussels very little effort to show him just who was actually the capo di tutti capi. Why would the Lega/5-Star coalition fare any better? As an aside, the Cavaliere is actually back in action these days, proving that he remains astonishingly resilient.

 

Comeback king Uncle Silvio, once upon a time unceremoniously deposed by Brussels, is back in the thick of things.

Photo credit: AFP

 

On the other hand, one could well argue that the trigger does not really matter and that it has simply pushed the market to a level that is more closely aligned with reality than the bizarre Potemkin village constructed by ECB intervention.

There is another caveat though: US high yield spreads have failed to mimic the action in Europe so far. No breakout over lateral resistance is in evidence. In fact, effective yields on the lowest-rated US junk bonds (CCC or lower) have recently declined even further – presumably because many of these were issued by energy companies, which are currently supported by fairly high crude oil prices. Yields on better-rated junk bonds have increased, but so have treasury yields. As a result there was no effect on spreads:

 

US high yield spreads (BofA-ML Master II Index) – no breakout is in sight yet, but obviously this needs to be watched closely now.

 

Conclusion

Given the circumstances and the lack of “contagion” one might want to wait for US junk bond spreads to follow suit before jumping on the new trend. Keep in mind though that euro-area spreads were a leading indicator on the way down and the same may turn out to be the case on the way up. In short, at the very least the breakout in European junk bond spreads constitutes a warning sign for risk assets – which happens to be in line with the sharp slowdown in money supply growth since late 2016.

 

Charts by: AM, data by St. Louis Fed / BofA-ML

 

 

 

Emigrate While You Can... Learn More

 


 

 
 

Dear Readers!

You may have noticed that our so-called “semiannual” funding drive, which started sometime in the summer if memory serves, has seamlessly segued into the winter. In fact, the year is almost over! We assure you this is not merely evidence of our chutzpa; rather, it is indicative of the fact that ad income still needs to be supplemented in order to support upkeep of the site. Naturally, the traditional benefits that can be spontaneously triggered by donations to this site remain operative regardless of the season - ranging from a boost to general well-being/happiness (inter alia featuring improved sleep & appetite), children including you in their songs, up to the likely allotment of privileges in the afterlife, etc., etc., but the Christmas season is probably an especially propitious time to cross our palms with silver. A special thank you to all readers who have already chipped in, your generosity is greatly appreciated. Regardless of that, we are honored by everybody's readership and hope we have managed to add a little value to your life.

   

Bitcoin address: 12vB2LeWQNjWh59tyfWw23ySqJ9kTfJifA

   
 

Your comment:

You must be logged in to post a comment.

Most read in the last 20 days:

  • America Goes Full Imbecile
      Credit has a wicked way of magnifying a person’s defects.  Even the most cautious man, with unlimited credit, can make mistakes that in retrospect seem absurd.  But an average man, with unlimited credit, is preeminently disposed to going full imbecile.   Let us not forget about this important skill...  [PT]   Several weeks ago we came across a woeful tale of Mike Meru.  Somehow, this special fellow, while of apparent sound mine and worthy intent, racked up...
  • Retail Capitulation – Precious Metals Supply and Demand
      Small Crowds, Shrinking Premiums The prices of gold and silver rose five bucks and 37 cents respectively last week. Is this the blast off to da moon for the silver rocket of halcyon days, in other words 2010-2011?   Various gold bars. Coin and bar premiums have been shrinking steadily (as have coin sales of the US Mint by the way), a sign that retail investors have lost interest in gold. There are even more signs of this actually, and this loss of interest stands in stark...
  • Credit Spreads: Polly is Twitching Again - in Europe
      Junk Bond Spread Breakout The famous dead parrot is coming back to life... in an unexpected place. With its QE operations, which included inter alia corporate bonds, the ECB has managed to suppress credit spreads in Europe to truly ludicrous levels. From there, the effect propagated through arbitrage to other developed markets. And yes, this does “support the economy” - mainly by triggering an avalanche of capital malinvestment and creating the associated boom conditions, while...
  • Gold Divergences Emerge
      Bad Hair Day Produces Positive Divergences On Friday the ongoing trade dispute between the US and China was apparently escalated by a notch to the next level, at least verbally. The Trump administration announced a list of tariffs that are supposed to come into force in three week's time and China clicked back by announcing retaliatory action. In effect, the US government said: take that China, we will now really hurt our own consumers!  - and China's mandarins replied: just you wait, we...
  • Industrial Commodities vs. Gold - Precious Metals Supply and Demand
      Oil is Different Last week, we showed a graph of rising open interest in crude oil futures. From this, we inferred — incorrectly as it turns out — that the basis must be rising. Why else, we asked, would market makers carry more and more oil?   Crude oil acts differently from gold – and so do all other industrial commodities. What makes them different is that the supply of industrial commodities held in storage as a rule suffices to satisfy industrial demand only for a...
  • Chasing the Wind
      Futility with Purpose Plebeians generally ignore the tact of their economic central planners.  They care more that their meatloaf is hot and their suds are cold, than about any plans being hatched in the capital city.  Nonetheless, the central planners know an angry mob, with torches and pitchforks, are only a few empty bellies away.  Hence, they must always stay on point.   Watch for those pitchfork bearers – they can get real nasty and then heads often roll quite literally....
  • Lift-Off Not (Yet) - Precious Metals Supply and Demand
      Wrong-Way Event Last week we said something that turned out to be prescient:   This is not an environment for a Lift Off Event.   An unfortunate technical mishap interrupted the latest moon-flight of the gold rocket. Fear not true believers, a few positive tracks were left behind. [PT]   The price of gold didn’t move much Mon-Thu last week, though the price of silver did seem to be blasting off. Then on Friday, it reversed hard. We will provide a forensic...
  • Merger Mania and the Kings of Debt
      Another Early Warning Siren Goes Off Our friend Jonathan Tepper of research house Variant Perception (check out their blog to see some of their excellent work) recently pointed out to us that the volume of mergers and acquisitions has increased rather noticeably lately. Some color on this was provided in an article published by Reuters in late May, “Global M&A hits record $2 trillion in the year to date”, which inter alia contained the following chart illustrating the...
  • Cryptocurrency Technicals – Navigating the Bear Market
      A Purely Technical Market Long time readers may recall that we regard Bitcoin and other liquid big cap cryptocurrencies as secondary media of exchange from a monetary theory perspective for the time being. The wave of speculative demand that has propelled them to astonishing heights was triggered by market participants realizing that they have the potential to become money. The process of achieving more widespread adoption of these currencies as a means of payment and establishing...
  • The Fed's “Inflation Target” is Impoverishing American Workers
      Redefined Terms and Absurd Targets At one time, the Federal Reserve's sole mandate was to maintain stable prices and to “fight inflation.”  To the Fed, the financial press, and most everyone else “inflation” means rising prices instead of its original and true definition as an increase in the money supply.  Rising prices are a consequence – a very painful consequence – of money printing.   Fed Chair Jerome Powell apparently does not see the pernicious effects...
  • A Walk on the Wild Side
      A Walk on the Wild Side   “Never play cards with a man called Doc.  Never eat at a place called Mom’s.  Never sleep with a woman whose troubles are worse than your own.” – Nelson Algren, A Walk on the Wild Side   Fresh Fruit or Rotting Vegetables? A subtle gas seems to always be vented into the atmosphere at the sunset of an extended bull market.  As the light fades, an odor that’s indiscernible from that of fresh fruit or rotting vegetables wafts down...

Support Acting Man

Item Guides

j9TJzzN

The Review Insider

Dog Blow

Austrian Theory and Investment

Archive

350x200

THE GOLD CARTEL: Government Intervention on Gold, the Mega Bubble in Paper and What This Means for Your Future

Realtime Charts

 

Gold in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Gold in EUR:

[Most Recent Quotes from www.kitco.com]

 


 

Silver in USD:

[Most Recent Quotes from www.kitco.com]

 


 

Platinum in USD:

[Most Recent Quotes from www.kitco.com]

 


 

USD - Index:

[Most Recent USD from www.kitco.com]

 

Mish Talk

 
Buy Silver Now!
 
Buy Gold Now!
 

Oilprice.com