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Milk and Honey?

05 April 2019 by jbchevrel

In Q1, CDX HY has tightened -110bp, up c5% to the highest in more than 6 months. In cash space too, US HY bond funds got the biggest inflow in 10 weeks, close to $2B. HY bonds had their best Q1 since 2003, the Bloomberg Barclays US HY TRI gained +7.6%. Within the iBoxx HY index, the only sector which failed to tighten by more than 100bp in Q1 was ‘Consumer’. Low supply helped that move. Indeed, March supply came at $20.4b, down 21% from March 2018, making it the slowest 3rd month since 2009 and making Q1-2019 the lowest Q1 issuance since 2016. We saw 78 deals totalling $59B. And if supply slows, demand is still there, partly thanks to the Fed’s earlier change of path. Most deals were oversubscribed by multiple times. Other factors include better-than-feared earnings, firm oil (WTI highest in almost 6 months) and above all a dovish Fed (70% of a 25bp rate cut priced in by the end of this year). Indeed, we saw US financial conditions ease the most steeply since Feb16-Apr16 period, and yields we dragged down by the sharp rally in rates (10y yield went from 3 ¼ to 2 ½). The HY market seems very resilient to the increasing expectations of a US recession over the coming quarters. Indeed, the NY Fed sees the probability of a US recession in the next 12 months at 27%. UST 2s10s is not inverted but fairly flat (16bp) and historically, US recessions follow 2s10s inversions with an average lag of 18 months (22 months for GFC, 13 months for Dot Com etc). One might think that this is fine, because the curve shows a 2s10s priced 8bp steeper 1y forward. This is forgetting that prior to several recessions in the past, the Fed, panicked, eased and steepened the curve, failing to avoid the recession. The amplitude of that steepening reached ~2bp in 2s10s prior to both Dot Com and GFC.