Europe's Junk Bond Bubble Has Lastly Burst

From ZeroHedge, Oct 6:

Earlier this week, the euphoria over USA high yield bonds hitting novel post-crisis highs when with a abrupt slowdown inward supply, a ascent inward the fossil oil cost in addition to by in addition to large company economical conditions, insatiable buyers of junk sent the Bloomberg Barclays Corporate high yield spread to the lowest since earlier the fiscal crisis, dropping equally depression equally 303bps, the tightest grade since belatedly 2007 earlier drifting somewhat wider during the belatedly calendar week bond rout.

Yet spell the USA high yield marketplace seat remains remarkably resilient inward the facial expression upwardly of sharply higher yields, the same tin non hold upwardly said of European junk bonds where the bubble may convey finally burst.

As Bank of America's Barnaby Martin writes inward his latest inquiry note, inward stark contrast to shrinking USA spreads, European high-yield spreads convey blown out past times 70bp wider, with full returns simply +13bp, a far cry from the average annual returns of +11% observed over the finally decade. Putting this dramatic reversal inward context, at the showtime of the yr Euro HY spreads were 80bp tighter than USA spreads. Now they are 35bp wider, inward large business office due to the deterioration inward the Italian backdrop, concerns virtually the halt of the ECB's QE in addition to the recent deterioration inward the European economy. 

As Martin shows inward the nautical chart below, "one has to decease dorsum to belatedly 2012 to bring out that finally fourth dimension that Euro HY spreads were this broad to USA spreads." Also notation the variance inward quality: 41% of the USA HY marketplace seat is single-B versus simply 24% inward Europe.

What has prompted this curious reversal inward the fates of the European in addition to USA junk bond markets? According to Martin, a cardinal topic for European adventure assets inward full general is that Quantitative Tightening past times the Fed has made unproblematic "cash" inward the USA a competitive property cast again.

We recall this dynamic is probable to weigh on European high-yield spreads in addition to too deed equally a barrier to meaningful retail inflows returning inward Europe.

This dynamic is pose out inward the nautical chart below, which shows the yield on European BBs versus the yield on USA 6M Bills. Martin highlights that neb yields convey acted equally a "lower bound" to European high-yield spreads this yr (the USA Dollar has too been rising since mid-April ’18). If that is the case, yields volition exclusively drift wider equally USA cash rates decease fifty-fifty to a greater extent than attractive equally 3M USD Libor is increasing again, in addition to the Fed volition probable hike rates at to the lowest degree simply about other iii charge per unit of measurement hikes past times the halt of ‘19, to the detriment of the European high-yield market....

 Two other reasons for European junk bond weakness are the effect of composition, namely i) the high weighting of Italian names inward Euro HY (17%) in addition to ii) the prevalence of credits with EM revenue exposure. As a effect of the electrical current volatility inward both of these
corners of the market, Martin believes that in that location volition hold upwardly fifty-fifty to a greater extent than headwinds to Euro spreads. Chart four shows the implied acquit upon of blowing out Italian yields on European junk, spell Chart v shows that Euro HY spreads convey had a reasonably high correlation to EM FX volatility over the finally few years (BofA's strategist too notes that the recent boundary inward the USA Dollar volition probable Pb to simply about other circular of EM currency weakness shortly).

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