Volatility has strongly receded in high yield, diverging meaningfully with the trajectory in equity volatility that remains well above historical lows. This is another indication of rising complacency and a disconnection between typically very correlated risk premia. Beta to equities has decreased materially too, which also explains the divergence in volatility compression between the two asset classes.
Stocks have room to expand multiples further, driven by flows and the lack of decent alternatives, while current pricing and positioning in credit leaves little room for further spread compression. Credit is also vulnerable to macro shocks and global deleveraging, but lower liquidity in the asset class makes it more sticky and typically less impacted by technical sell-offs than equities. During the last week of January, the MSCI World index dropped by 4% but major high yield indices only lost 75bps, less than half the loss historical correlations would have implied.
Consequently, we believe that positioning and sentiment in credit has reached extremely high levels, leaving it vulnerable to the high macro volatility environment and inflation risk that we expect in the year ahead. Spreads have bottomed over the short term and we expect little spread compression, if not widening.
Source: Bloomberg, Unigestion. Data as at 22 February 2021.
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