Junk Bond Selloff: More Than A Pullback?

August 12, 2014

CDS Spreads

The S&P/ISDA CDS U.S. High-Yield Index measures the average spreads (prices) that one will have to pay to buy protection against 80 equally weighted reference U.S. entities. (Three-year index data is available for free via S&P Dow Jones Indices.)

The index is quoted in basis points. That means the higher the index, the more costly it is to purchase default protection against the underlying entities collectively. It is a rough gauge of the market’s appetite for credit risk, or anxiety over default risk.

The chart below plots both the CDS index against the high-yield OAS series to see if there is any correlation between market’s sentiment on default risk and OAS.

CDS_Spreads

As one can quickly see, high-yield OAS is practically moving in lock step with CDS spreads.

Looking at July onward, there seems to have been a real turning point for the high-yield market, as there was a meaningful uptick on CDS spreads. That means that either there was an increase in fears of default risk or a reduction in appetite for credit risk. OAS spiked during the same period too.

When put together, the upticks in CDS spreads and high-yield OAS lead me to believe that something else is brewing in the high-yield space. The sell-off is more than a pullback. Investors are either nervous about default risk or don’t have much appetite for further credit risk at this point.

Either way, they demand higher compensation in the form of OAS for taking on additional credit risk.

While these two benchmarks are far from conclusive, or all-encompassing, they are readily available indicators of what’s going on in the bond market, and offer investors of all sizes—and expertise—a good barometer for the market’s risk appetite.

 


 

At the time this article was written, the author held no positions in securities mentioned above. Contact Howard Lee at [email protected].


Find your next ETF

Reset All