High Yield Bond Shorts Hit Record Highs Amid IG Credit's Worst Year Since Lehman

2018 is looking like being the worst year for investment grade credit markets since 2008's Lehman-led collapse...

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And worse still, Citigroup's analysts are wary that the clock is ticking for the riskiest corporate bonds...

“The markets are entering a new phase of increased volatility,” they wrote, and “we are a long way from a sustained high yield recovery”.

Prices for bonds rated CCC or lower (the weakest high yield credits) have dropped about 8.7% since the credit selloff started in early October, according to Bank of America Merrill Lynch Indexes. And as prices fall, yields on CCC-rated bonds have climbed to 11.5%- well above the current coupon around 8.1% (meaning dramatically higher refunding costs).

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As about 34% of CCC-rated bonds come due in the next four years, up from 20% in 2010, according to Citigroup, Barrons notes that these companies will need to decide whether to pay down debt or refinance at higher rates. Either way, they will need to focus on cash.

All of which perhaps explains why, as The Wall Street Journal reportsbond investors scrambling to protect themselves from losses are increasingly using bets against the largest junk-bond ETFs.

The value of bearish bets on shares of the two largest junk-bond ETFs hit a record $10 billion in recent weeks, according to data from IHS Markit.

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A record 59% of shares outstanding of the largest junk-bond ETF have been sold short, up from about 35% in September, according to data from S&P Global Market Intelligence.

WSJ reports that appetite to short the ETF, operated by iShares, has far exceeded the number of shares available to borrow; ETF brokers have created an estimated $2 billion new shares to meet the demand since the start of October, said IHS Markit analyst Samuel Pierson. Short sellers of stocks and bonds are constrained by the amount of securities they can borrow. But ETF brokers can create new shares specifically to lend them out, allowing for much larger bearish positions.
 

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