July’s BAML credit survey reveals that tapering talk in the US and the recent sharp jump in yields has altered some big technical in credit. Primarily, the inflow picture is decidedly weaker since May’s survey. Only a net 17% of investors have seen inflows exceed outflows over the last 3m, well down on the previously robust level of 48%. While the picture for institutional investors is still one of inflows then (in contrast to the picture for retail investors) these have nonetheless declined to their lowest reading since December 2011. BAML also asked what yield on the ten year would really concern the Credit analysts. See below for an excerpt from the report and the answer to that question.
Barnaby Martin of BAML: Fear of the Fed
Small risk reduction amid liquidity constraints
Aggregate overweights on credit have fallen in the last few months, but not by a material amount. Poor liquidity has been cited as a constraining factor to big selling. A net 23% of investors remain overweight credit, down from a net 36% in May, but this only takes the aggregate overweight back to its 5yr average.
Switching beta, not avoiding it
What’s clearer from July’s survey is that investors have become much pickier in their beta exposure, switching a number of their sector longs. Tier 1 underweights are larger (although note the survey was conducted prior to the EBA Q&A release), but sub insurance overweights have risen. Industrial and corporate hybrid overweights are lower, but positions in telecoms and utilities are longer. Importantly, high-grade investor cash levels remain wrapped around their longterm average of 4.3%.
Big bearishness in senior banks ? time to go long?
The big sentiment shift lately has been in senior banks, in light of the new EU bailin announcements. Underweights in the sector have doubled from a net 18% to a net 35%. Investors are not convinced that banks will respond to the bail-in regime by issuing more subordinated debt to “protect” their senior bonds. Only 55% of investors expect this, and if they don’t issue more sub investors fear senior spreads could widen by around 40%.
Front-end longs starting to look crowded
The recent re-emergence of a “safety bid” in credit has resulted in overweights in 1-5yr bonds increasing to their largest since June last year. A net 39% of investors are now overweight here. Conversely, overweights have fallen materially in 5-10yr bonds (from a net 34% to a net 6%).
Pressure points: watch out for a 3% yield on 10yr treasuries
While the ECB has distanced itself from the pack, Euro credit investors still worry about rising US treasury yields provoking outflows. The critical yield level that investors are watching on 10yr US treasuries (to drive further outflows and spread widening) is 3.15% for high-grade investors, and 3.05% for high-yield investors.
Outflows and rising yields
We asked investors what yield on 10yr US treasuries would make them a lot more concerned about credit fund outflows and spread widening.
- On average, high-grade investors would be concerned when 10yr treasury yields hit 3.15% (Chart 1). High-yield investors would be concerned when 10yr yields reach 3.05%.
- Clearly, 3% is a crucial level as the chart shows. 50% of investors feel that this would be a worrying level.
- 12% of investors would be worried at 3.5% yields, and 10% of investors would be worried at 4% yields.
The bail-in diaries
Following the announcement of the EU common approach to bank resolution, we asked investors if they expect banks to issue a lot more sub debt going forward to help reduce worries about senior debt being bailed-in.
- Investors seem relatively split on this. 55% expect that banks will issue more sub debt. However, 45% of investors think banks will not (Chart 2). In addition, we asked investors how much they thought senior spreads would widen (in percent terms) if banks did not respond to the bail-in announcements by issuing more subordinated debt.
- The average senior spread widening expected is 38%. This implies spreads on BofAML’s senior bank index will widen from 135bp to 187bp.
- The majority of the investors see a 30-50% widening in spreads (Chart 3).
- However, there are “wings” to the distribution. 12% of investors do not expect senior spreads to widen. Yet 13% expect senior spreads to double (or more) if banks don’t issue more sub bonds
High-yield investor survey
Our dedicated high-yield investor survey shows that institutional investors have trimmed their overweights, as more than $9.7bn of outflows have hit European high-yield retain funds during the month of June.
July’s survey revealed that investors’ net overweight on high-yield has
reduced from 40% to 25% (Chart 4).
- Sector-wise, investors have reduced risk in high-beta sectors and sectors that are more exposed to EM: underweights have increased in corporate hybrids and metals & mining.
- Financials have also seen their previous overweight now reduced to a noticeable underweight.
- That said, not everything has been shunned. Telecom and consumer longs have been increased. A small underweight in healthcare has been changed into a noticeable overweight (Chart 26).
- Investors have also reduced duration, as both mid-term and long-term risk has been reduced, while overweights have increased in short-term paper on a net basis (Chart 23).
- Despite the record outflows from high-yield retail funds, the average cash weighting in our survey has increased to 5.7%.
What’s your number?
As a special question, we asked high-yield investors what level of 10yr treasury yields would get them a lot more concerned about credit outflows and spread widening. When we started our survey, 10yr treasury yields were 2.5% (Chart 5).
- The majority of high-yield investors (50%) indicated that at that they would get more concerned about credit outflows and spread widening at 3% yields on 10yr treasuries.
- Views were fairly equally distributed outside around the 3% mark, as can be seen.