Credit Rumbles But Juice Left to Squeeze

Rising Rate environment.  War in Europe.  Inflation printing at levels seen 50 years ago.

Known knowns so they’re priced in, right?  I suspect so.

Last week’s price action in equities is being widely viewed as a short-covering event.  And there is a plenty of evidence to support that notion, which I agree with.  But that doesn’t mean we haven’t seen a potential legitimate shift in animal spirits for risk assets, at least in the short term.

We’ve gone from 0.00% to 0.25% on the Fed Funds rate.  Threats of an additional 50 basis points if and when needed at any of the next FOMC meetings and potential initiation of balance sheet runoff by the start of Summer

With 6 remaining meetings in 2022, you at least have a printed schedule of interest rate risk-events.

2022 FOMC Remaining Meeting Schedule (b)

If the known knowns are essentially priced in, then how much volatility is left to sell and hedge?  Which brings me to junk or rather high yield (HY).  With the start of the year, the HY spread began to widen, but I suspect with current risks digested, people are still going to stretch for yield.

Over the past few years, each spread-widening event has been met with subsequent compression.  Observe.

HY Option Adjusted Spread

Why?  Because interest rates are so low and capital requires yield.  End of story.

Rates are still historically low and the Fed’s balance sheet liquidation process still awaits.  This means liquidity.  Recession risk is obviously rising as earnings will assuredly contract, but again, what’s priced-in in the short-term?  I’d wager more than speculators suspect.

HYG is sporting a meaty 4.25% yield and a slight discount to NAV to boot at the time of article composition.

Sentiment in HY has reached an extreme, as observed in the HY McClellan Summation (courtesy of SentimenTrader).  Observe an extreme not seen since the GFC.

HY McClellan Summation (3-21-2022)

Additionally, debt-volatility as measured by the MOVE (courtesy of TradingView) has begun to abate.  Is the worst over?  Not sure, but there’s enough signs to wager yes in the short-term at the very least.

The MOVE

Let’s take a look at HYG from a technical standpoint.  A couple of things jump out.  One, the buying thrust in volume last week (200M+ shares traded).  Over the past few years, this level of green volume has typically led to solid, multi-week or month rallies as noted by the yellow circles.  Couple failures (red circles) in 2020 as the world was being taught how to live with a pandemic.  Different environment now.

HYG (3-21-2022)

HYG has also bumped down into it’s 150-week EMA.  Nothing magical about that, but it did prove to be a stopping point at the end of 2018 when people were thinking the next GFC was upon us.

Huge risks are everywhere.  None can be marginalized but they do have to be appropriately discounted and I think the markets are doing that now.  If you’re looking for yield and maybe a bit of capital gain, HYG is worth a look at structuring a play.

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