Hey Monkeys, I'm a LMM-MM private markets guy looking to learn more about public market dynamics.
I heard a reputable senior professional say that after the 75bps J Pow hike there was a 6% equity markets drawdown, and a 6-8bps widening of credit spreads, but in reality that 6% equity drawdown should have been met with a 15bps widening of credit spreads.
With that being said, how does one determine the "appropriate" amount the credit spreads will widen based on a certain level of drawdown in the equity markets? Is there a rule of thumb?
All factors being equal, according to this guy, this 6% shift "should've" widened credit spreads 15bps. What is the relationship between equity drawdowns and credit spreads? (outside of the obvious directional answer)
So I really have no idea if there is an equation based linkage here, and I am sure some proper credit guys can school my ass here when it comes to using CDS and other options implied vol stuff to figure out the answer. At my firm where I do some fixed income work on top of equities, I generally will look at where credit spreads have traded in times of previous dislocations and that will give me some insight (ex: last time we saw spreads move "x" bps). For my take today, we are still seeing corp. IG trading much tighter than in previous periods with similar characteristics and it should become more attractive once we surpass +200bps-250bps. With the type of investing we do, a difference of 7bps widening doesn't mean much to us so I can tell I am already way off basis probably.
Mostly bumping here to get a real answer lol.
Thanks, I was really asking from the point of view of a basic IG/HY corporate bond investing standpoint.
This was brought to my attention because many are saying the credit spreads haven't properly priced in the current rate hike nor are they priced in anticipation for further interest rate hikes.
I also heard something about some corporate bond market distress index showing that IG bonds are at higher levels of stress than HY (which logically one would think is extremely unlikely) but what this really reflects is a crisis of liquidity (IG bonds are more liquid than HY bonds, so in a crisis of liquidity the IG takes the first hit) and not a crisis of credit like previous recessions. A crisis of credit would reflect HY bonds being under higher stress than IG but since that isn't the case it is simply about liquidity and the action in the bond markets.
I'm still new to this and trying to learn as much as I can so hoping someone else can chime in and provide some additional perspective
Compared to sell offs/ recessions, you are correct as IG spreads usually go out to ~250bps while HY usually goes out to 900-1000bps (this is skewed by 08 data, and again we don't have tons of data points to work off of here, but this is what I found vs. prior 6 stress periods/ slowing growth/recession). Today we are at ~160bps on IG and ~500 something on HY.
HY bond fundamentals as an asset class are technically stronger than usual, as default rates look like they will be much lower than usual, and other data looks good (better interest coverage, lower leverage, less Energy in HY and better energy fundamentals going forward, etc.). I wouldn't extrapolate this out to mean a lot going forward, but it is worth consideration. (Also Howard Marks had a good write up once on default rates in HY and being adequately compensated to make money, worth a read). The bear camp talks about too much cov-lite issuance and growing size of loan market etc., and prob a million other things to why credit is in a tough spot.
Anyways back to your point... I would suppose people are saying that with respect to 1) implication that rates need to move up further following last hike and 2) FED is signaling, or at least increasing the signal, that we will need recession to tame inflation, in which case spreads need to be higher - mostly both point to absolute yields needing to be higher to compensate us given these risks. Idk much about the relative liquidity factors here as I haven't done much work there.
Credit is weird - all about capped upside and examining the downside, the relative return profiles, and trying to extrapolate what rates are telling you about conditions and what the implications are for the future. I'm just an equity guy out of my league though so lets wait for someone else.
Thanks man awesome response. Do you have a link to that Howard Marks thing? I tried to look but I couldn't find it
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