Tuesday, February 16, 2016

Credit Markets Remain A Huge Problem.........

Credit Markets Remain A Huge Problem

The missing link in the current downturn is improvement in the credit markets, which has failed to materialize. Credit default swaps on investment grade (IG) and high yield (HY) corporate bonds keep heading higher with recent levels well above their October 2015 highs as well as their January 2016 highs, reaching their highest levels in five years.

US corporate high yield option adjusted spreads (OAS) are nearing their 2011 highs with no improvement and their spread to US Treasuries continues to creep higher as they too approach their 2011 levels.

Credit markets weakened in the wake of Yellen's rate hike in December, which suggests it was a policy error, particularly when viewing the tightening that already took place since 2014 as seen by the Atlanta Fed's Shadow Federal Funds Rate, which also coincided with a peak in global currency reserves. These two factors suggested that global liquidity and financial conditions were worsening and this was the environment Yellen raised rates in.

An important 
watch point is the Japanese Yen, which is moving in the wrong direction and peaked on January 29th the day the Bank of Japan (BOJ) joined the negative interest rate party. Rather than having a stimulative boost, the move was treated by investors as a policy error and the Yen has strengthened sharply in the last two weeks against the USD. The recent peak in January tested the underside of the broken trend that was in place when Abenomics first began in 2012 and continues to strengthen, which, historically, has not been a good sign for the markets when the yen carry trade unwinds.

We need to see improvement in the credit markets and corresponding stabilization in the following areas:

European Banks
Japanese Yen
US Junk Bond Market
Oil prices

As seen by the chart below, these areas continue to see new lows with no signs of stabilization. Until these areas and credit markets improve a bottom will remain elusive.

China, continues to slow and is likely to remain a big wild card this year and an ongoing concern for some time, meaning even if we have a decent intermediate rally in the weeks ahead, this year is likely to prove quite difficult for investors with risk management playing a paramount role.

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