Despite Middle East tensions driving oil prices up, high yield bonds outperformed Treasuries as strong cash inflows offset geopolitical concerns.
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Welcome back to The Weekly Fix. My name is Peter Keenan, senior trader for leveraged credit on the RBC BlueBay fixed income team in Stamford Connecticut.
Investors came into the offices on Monday morning with a risk-off mindset as headlines out of the Middle East dominated the weekend news flow. Missile volleys and drone strikes were exchanged, and markets opened in nervous anticipation of how risk assets would react.
As a measure of sentiment, the VIX closed at 20 on Friday, was as high as 25 in early morning hours, but as of Monday afternoon it was off the highs of the day at 21, and trending back towards unchanged. Equities have similarly rallied back to roughly flat. Meanwhile, in credit, the CDX HY credit derivative index is modestly higher in price.
While stocks seem to have digested the weekend’s headlines, oil remains higher on the day with Brent crude futures up nearly 6% as supply concerns remain under the threat of closure of the Strait of Hormuz.
As I consider which of these markets will ultimately have the greatest impact on High Yield bond prices, I’m most focused on the reaction in US Treasuries. Yields on maturities between 2 years and 10 years are higher by 12 to 13 basis points across the curve, alongside a 2-basis point flattening of the 10s/30s curve, now at a 65 basis point spread.
Technically, the rates market had been positioned long, as investors anticipated a more accommodative Fed under Kevin Warsh. Today’s market reaction reflects an unwinding of those positions as rising oil prices raise concerns about a more persistent inflation backdrop and potentially fewer rate cuts than expected.
Turning specifically to the high yield market, most conversations I had this morning with sell side investment banks revealed that investors were hoping for a dip to buy. Dealers were looking to source risk at lower prices, but when everyone is trying to do the same thing at the same time, it rarely materializes.
Generic high yield bonds are lower by 25 to 50 cents today but outperforming comparable duration US Treasuries. Some higher beta issues are down closer to a point.
So why has high yield had such a muted reaction to headlines overseas, even outperforming risk-free bonds?
As is often the case, market technicals are playing a significant role. Positioning already leaned conservative, as markets had been choppy in recent weeks amid ongoing volatility driven by concerns about AI driven disruption in various industries, especially in software and technology. But US High yield investors are about to receive 8.9 billion dollars of cash this week, in the form of coupons, calls, and maturities. At the same time, geopolitical activity will likely sideline corporate issuers who otherwise might have come to market with new supply this week. So Monday’s market reaction is perhaps a function of too many investors being forced to buy into a market which is likely to be supply constrained. The technical strength of this market seems strong enough to weather geopolitical risk, at least as long as investor interest in the asset class remains strong and outflows are minimal.
Thank you for your time and see you on the next edition of the Weekly Fix.
Key points
Muted market reaction to geopolitical risk: While oil surged and Treasury yields rose on Middle East tensions, high yield bonds fell only moderately and outperformed duration-equivalent Treasuries.
Technical factors dominate fundamentals: Conservative positioning and strong incoming cash from coupons, calls, and maturities created forced buying pressure.
Rate repricing on inflation concerns: Treasury market unwound long positions as rising oil prices raised fears of persistent inflation and fewer Fed rate cuts under new leadership.
