The Belly Tailed. Credit Shrugged.
Something unusual happened this week, and it is the kind of thing that usually matters later rather than on the day. The price of government money went up sharply: the US 10yr yield reached about 5.11%, its highest in 19 years, and the Treasury's $70bn sale of 5yr notes on Wednesday drew the weakest demand since 2018 - a 3.1 basis point tail against a recent average of 0.6, with foreign buyers taking their smallest share since March 2020. The price of corporate risk went the other way. The extra yield investors demand to hold high-yield debt fell to 2.68%, near the tightest in 3 years, and every rating tier tightened, from investment grade down to CCC. Normally those two move together. When they don't, one of them is mispriced - and the rest of this piece is about which one, and what would prove it.
The gap widened
Last Thursday the divergence was a 10yr at 5.01% against high yield OAS at 2.76%. 7 days later the 10yr has traded 5.11% and high yield OAS is 2.68%. The risk-free curve moved 10 to 15 basis points in the direction of more policy, and the compensation for default risk narrowed 8 basis points. This is the widest the two have been apart since this repricing began. One of them is wrong about the next 12 months.
Every rung, same direction
There is no quality split to hide behind. Taking the same two dates, investment grade OAS went 0.80% to 0.77%, BBB 0.98% to 0.95%, BB 1.61% to 1.56%, and CCC 10.85% to 10.75% (all 22 September, against 15 September).
The bottom rung is the one that matters. If credit were beginning to price something, CCC is where it would show first - it has the widest absolute spread and the weakest balance sheets behind it. It is 10 basis points tighter on the week, in line with every rung above it.
Where 2.68% actually sits
Our high yield OAS series runs back to September 2023, 785 observations. At 2.68% the index is in the 5.9th percentile of that window; the low is 2.59%, set earlier this month. So the market is charging 9 basis points over the tightest print in 3 years for the whole high yield index, at the same moment the 10yr is trading at its highest level in 19 years. Percentiles here are of level, so a low number means a tight spread - and this is close to as tight as the series gets.
What the listed market says
The funds are not behaving like an asset class under stress. HYG at 78.68 is up 0.15 on the week, JNK at 94.71 is up 0.22, and LQD at 105.09 is up 0.79. The S&P closed at 7,706.03, down 58.67 on the day. VIX at 15.18 sits in the 7th percentile of its own 3yr history. A credit market repricing default risk falls first and fastest in the high yield funds; these are drifting higher while the curve reprices.
The vol mismatch is the cleanest read
MOVE closed at 95.45 from 81.20 - a 14.25 point move in rate volatility in a single week. Equity volatility is in the 7th percentile and credit spreads are in the 6th. Exactly one market is repricing risk, and it is the market whose instrument the government is currently issuing in size. That is a rates-volatility event passing through a credit market that has not marked it. It is also the reason the cheap thing here is convexity, not direction.
The marginal buyer is not the same buyer
Yesterday's $70bn 5yr cleared at 5.033%, the highest auction yield for that maturity since June 2006, with a 3.1 basis point tail against a six-auction average of 0.6 and a bid-to-cover of 2.21, the lowest since December 2018. Indirects took 54.3%, the lowest since March 2020, and dealers absorbed 15.77%. The marginal buyer of the belly is price-sensitive and it walked. The marginal buyer of credit is funded and carry-driven - an insurer, a pension, an SMA that either takes a 2.68% index yield or gives up the yield. It does not get to walk. Two different demand curves, one repricing and one not, and that is why the gap can keep widening without anything breaking.
The part with no marks
Industry estimates put private credit near $3.8tn, with fund lives extended from 10 years toward fifteen and continuation vehicles now accounting for roughly 14% of exits. None of that appears in an OAS series. The credit stress that would matter in this cycle shows up as an absence of marks rather than as widening spreads, which means the index at the 6th percentile is not evidence that nothing is wrong - only that nothing has been marked yet. This is the same conclusion the metals complex reached on Tuesday from the other direction: the vulnerable part of the system is the part without a live price.
What would settle it
Two tripwires, both observable. Funding: SOFR at 3.85% against IORB at 3.90% is still negative, so cash clears below the administered rate - a price event, not a plumbing event. Cash flow: initial claims 196k (12 September) from 206k (5 September), still improving, and default risk is a function of cash flow before it is a function of rates.
Both say the same thing. Credit is right about the cash flow and it is the price that is wrong - 56 basis points for a BB balance sheet against rate volatility at 95 is not compensation, it is a place to be short convexity. The print that would change this is not a spread print at all. It is a funding print.