The energy sector may account for a good proportion of risky credit, but that doesn’t necessarily mean that all negative price action in high yield and junk is entirely energy. While certain markets have regained comfort with the world’s various potentials, the outer echelons of US credit remain on alert. That is typically the pattern of an impending inflection in risk, as the most leveraged and highest potential beta positions are going to move first.
To that end, leveraged loan indications have not been anything like what they were prior to the illiquidity that developed from July to October 15. Prices may have stabilized from December lows, but that is nothing like the renewed enthusiasm of stock markets.
Again, I think this is the lack of available leverage and liquidity that is archetypal of a “tight” “dollar” period. It was surely liquidity that brought the immense growth to this area in the first place, traced back to the initiation of QE3. The artificial enthusiasm of low expected volatility (self-fulfilling) meant ample liquidity (including leverage) was on offer sufficiently dispersed in order to easily absorb addition junk supply without disrupting high pricing.
The S&P/LSTA Leveraged Loan 100 measures only the most liquid, meaning traded, leveraged loan obligations which gives us essentially the best case scenario for the entire space. Since liquidity acts upon prices at least proportionally, if not more so, then less liquid lending positions are likely to have fared worse than the proxy shown above.
This apparent lack of liquidity acts not just upon prices, but, as I suggested, in terms of issuance – the place where credit meets the real economy. All indications so far for the second half of 2014 are quite negative.
Issuance clearly tailed off in junk debt as the “dollar” problem gained traction in wider funding markets. Without liquidity to effectively absorb new supply, obligors have remained subdued and on the sidelines. That is interesting given that nominal yields in this arena still are historically low, suggesting that either high yield issuers are waiting for the “market” to settle down and continue the repressive behavior, or that they are ominously unable to absorb even a small increase in debt cost.
There is no way to tell which is the case at this point, however, this is not just a few months that are astray of the larger growth case. The first two quarters of 2014 essentially canceled each other out, but the second half has seen a nearly 20% decline in issuance volume from the last six months of 2013. As you can plainly see above, the problem is, at this moment, contained in high yield debt.
Credit spreads are rising in lower quality corporate which is a very serious erosion in what was supposed to be a sustainable “favorable” trend. Given what we can piece together from these various indications, there is a clear lack of liquidity, at least in comparison to the regime that dominated under QE’s cover. The result has been a systemic shift in both prices and supply, factors in combination that typically are associated with negative economic shifts.