‘Slo-Mo Credit Crunch’ Has Already Taken Hold, Bond Guru Says

(Bloomberg) -- It's no coincidence.

Stock market selloffs, volatility blow-ups, collapsing crypto currencies. They're all the symptoms of an unfolding global credit squeeze, according to famed HSBC Holdings Plc bond guru Steven Major. It just happens to be developing at a snail's pace.

Major and his team see what they call a “long list” of selloffs in risk market across the world as evidence of the disruption wrought by tighter dollar liquidity. In response they've slashed their forecast for bund yields, turned more bearish on credit and become even more cautious on emerging-market debt.

“Market participants are typically looking for validation of a forecast from cyclical data or one-off events but the reality can be different,” the bank's global head of fixed-income research wrote in a note on Wednesday. “We appear to be in the midst of a slow-motion credit crunch.”

The concerns reflect a wider angst growing across financial markets, which started the year in melt-up euphoria but reached the half-way mark in turmoil. Rising U.S. rates, the demise of the easy money era and President Donald Trump's approach to the established trade order have combined to drain cash from riskier assets.

For evidence the investment environment has got more challenging, look no further than Goldman Sachs Group Inc.'s U.S. Financial Conditions Index, which tracks changes in interest rates, credit spreads, equity prices and the greenback to provide a barometer of financial health. Having hit the lowest in almost two decades in January -- signaling easy conditions -- the gauge has performed a volte-face, and is steadily marching higher.

Japanization

The diminishing appetite for risk is one of the reasons HSBC cut its year-end forecast for 10-year bund yields to 0.4 percent from 0.75 percent, and even predicted a drop toward 0.2 percent in the short term. A downward reassessment of European Central Bank rate hike expectations, plus the potential for further turmoil in the governing German coalition, have added to the conviction.

Major acknowledges predicting bund behavior may be tricky, but proposes a possible solution: look east. As the ECB reinvests cash from its maturing bond pile, it may take a page from the Bank of Japan, which uses yield curve control to keep short-term and long-term rates at specific levels.

Since Haruhiko Kuroda and fellow policymakers introduced curve control in September 2016, JGB yields have not sustained a move above 10 basis points, according to Major. The Japanese 10-year benchmark currently yields 0.03 percent.

In developing markets, HSBC said the time has come to take a “selectively cautious stance” on local debt, alongside a bearish position on hard-currency obligations. Meanwhile, the bank adjusted its forecast on European investment-grade credit after spread widening eclipsed its initial prediction of a 30 basis-point increase in 2018. Now strategists led by Jamie Stuttard expect the iBoxx EUR Corporates Overall to widen 45 basis points over the course of 2018, to 95 basis points over equivalent maturity government bonds.

The strategists see high-yield spreads ending the year close to 400 basis points, about 150 wider than at the start, a more bearish forecast there too. The iBoxx speculative-grade gauge has hit 353 basis points, more than the 100 basis-point increase the firm had anticipated in 2018.

These views echo the verdicts of a host of Wall Street strategists and asset managers, many of who have been finding ways to short a credit cycle that looks increasingly long in the tooth. Money managers last month turned underweight European credit for the first time in seven years, according to a Bank of America Corp. survey.

“The autumn may bring further Italian volatility, ongoing trade headlines, and anticipation of the final fizzling-out of ECB purchases,” Stuttard and his colleagues wrote.

To contact the reporter on this story: Samuel Potter in London at spotter33@bloomberg.net

To contact the editors responsible for this story: Samuel Potter at spotter33@bloomberg.net, Cecile Gutscher, Sid Verma

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