And Credit Investors’ Biggest Worry Is…

By Heisenberg

So yeah, there’s certainly an argument to be made that as complacent as global equity markets surely are, credit is in fact the most complacent asset of them all.

Indeed, we’ve variously suggested that if stocks are asleep at the wheel, credit is passed the fuck out with its head in the toilet. That’s not just our assessment. Recall this rather amusing title that appeared on a Deutsche Bank note earlier this year:

Boring

Part of this is of course central banks and specifically, the ECB, which you’ll recall hasn’t actually tapered CSPP:

CSPP

That right there is why IG spreads didn’t blow out following the shocking result of the UK elections and generally speaking, the fact that Draghi is still snapping up billions in corporate bonds probably goes a long way towards explaining the steady grind tighter in € credit.

Have a look at the following chart from BofAML who notes that while IG spreads aren’t too far afield relative to history, “only 6% of European HY spread observations have been tighter than current levels.”

Spreads

Meanwhile, it looks as though CSPP is helping credit decouple from equities in Europe. As you can see from the following annotated chart, credit is still rallying despite flat stocks:

CreditVsStocks

So that’s the backdrop for BofAML’s most recent credit investor survey. As you’ll see below, basically no one is worried about anything. Populism and geopolitical conflict are still on the radar for both IG and HY respondents, but just barely.

Given that, can you guess what everyone is most concerned about? Well, when no one is worried about anything, it necessarily means that the only thing to fear are bubbles.

Sure enough…

Via BofAML

June’s survey suggests that the biggest risk for Euro credit over the next few months is that the market in fact ends up “chasing its tail” tighter. While investors have moved longer post the French elections, credit overweights still remain noticeably below the post-Lehman average, and few, if any, sector positions look worryingly crowded at present. But we think it’s cash levels that look the most supportive for spreads here. High-grade fund inflows have surged (8th biggest inflow ever) on the back of lower political risk, leaving investors with above-average cash positions, just at a time when new issuance is slowing compared to May’s hectic pace. And with credit investors struggling to pin down the big bearish risks for markets, we think they are rapidly coming to the conclusion that there is little to hold corporate bonds back from rallying. Note signs of “euphoria” lately in the credit market: iTraxx Europe spreads are almost 10% tighter in a week, while the European Stoxx 600 index has barely budged (see chart 1 for the conspicuous debt/equity divergence recently).

The fear…of missing out

Investors seem to be struggling to agree on tangible near-term risks that would ruffle the credit market (chart 3 and 4). Fewer now worry about an equity market correction or rising rates (especially in high-yield), and even populism is flagged as a key risk by only 8% of high-grade investors.

And so by default, more investors have been left worrying that as spreads inevitably head tighter the biggest risk is simply that we get “bubbles” in credit (chart 2 shows how historically tight some sectors now are)

Bubbles

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