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Revived Government Shutdown Risk Exacerbates Broad Selloff, High Yield Leads the Plunge

Revived Government Shutdown Risk Exacerbates Broad Selloff, High Yield Leads the Plunge

Rich Dvorak, Analyst

Talking Points:

  • Looming US government shutdown worsens already deplorable sentiment
  • Fed disappoints with a stance less dovish than hoped for by markets
  • Cratering crude oil prices and tightening credit conditions is killing high yield debt

The market selloff has created a bloodbath for investors as bullish sentiment vanishes. A threat to markets thought to be neutralized has re-emerged with President Donald Trump refusing to sign the stopgap funding bill to keep the US government from a shutdown. The recent development provided markets with a fresh dose of pessimism causing risk assets to continue their plunge.

S&P500 and High Yield Corporate Debt Price Chart

The high yield debt space has been a particularly noteworthy victim with one of its largest moves and worst performance since 2015. With a backdrop of slowing global growth, tightening credit conditions, and geopolitical risks a perfect storm has emerged and is spurring aggressive selling across risk assets.

High Yield Corporate Debt Performance Price Chart

The major US equity indices have notched fresh 52-week lows as bullish sentiment fails to catch bid once again. Now, the threat of a government shutdown adds to the crippling pessimism with President Trump stating he will not sign a spending bill without border security measures. Markets were hoping to catch their breath from the ongoing equity rout yesterday with a dovish Federal Reserve but were quickly disappointed after a 25bps interest rate hike and only 1 fewer projected hikes next year.

Liquidity in the credit markets quickly froze as lower GDP projections were digested causing spreads on corporate bonds to skyrocket. This has only continued the march higher in corporate credit spreads as the ongoing equity selloff has paralyzed risk taking sentiment.

Junk Bond OAS vs S&P500 Price Chart

Aside from rising interest rates and investors avoiding risk like the plague, cratering crude oil prices is another major factor causing the massive high yield debt selloff. Oil has taken a beating since lower global growth means less demand for the fossil fuel. This has resulted in crude collapsing 39.5 percent since October. Seeing that energy companies comprise approximately 15 percent of aggregate junk bonds, it should be no surprise that the aggressive selling in crude oil spills over to the high yield debt market. In fact, correlation between crude oil and high yield debt more than doubles to 0.3048 when the commodity is down 2.5 percent or more compared to a correlation of 0.1384 otherwise for a given week.

Crude Oil vs High Yield Corporate Credit Correlation Table.

--Written by Rich Dvorak, Junior Analyst for DailyFX

--Follow on Twitter @RichDvorakFX

--Check out our Education Center for more information on currency forecast and trading guides.

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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