The Spread Read, the Funds Did Not

High yield OAS is 3.03% (as of 6 Oct), 5 basis points back inside last Thursday's 3.08% (29 Sep). Over the same week the long end repriced higher and the listed credit funds drifted up, not down: HYG +0.312 and JNK +0.541. Only one of those two markets is pricing stress.

A credit spread is the extra yield an investor is paid for holding a company's debt instead of a government's. Last Thursday this column read the 6-session widening to 3.08% as a repricing of risk, and said the confirmation would be another widening week with the funds following. That confirmation did not arrive. The spread has given back 5 basis points and the listed funds have drifted higher, against a long end that repriced again. The question this piece answers is whether the retracement is the compression trade resuming or a pause inside a credit move that has not finished. Ahead: what the spread did, what the funds did instead, what the loudest rate weeks do not explain, and the two prints that would settle it.

The spread gave back a third of the move

High yield OAS is 3.03% (as of 6 Oct), from 3.08% (29 Sep) - 5 basis points tighter, back to where the 6-session widening began. The sequence since is 3.12% (30 Sep), 3.24% (1 Oct), 3.10% (2 Oct), 3.12% (5 Oct), 3.03% (6 Oct).

The peak was 3.24% on 1 October, the widest print of the sequence. It is 21bp above the 22 September low of 2.68%.

At 3.03% the index sits at the 50.2nd percentile of 785 observations back to October 2023. On 22 September it was at the 8.7th. The repricing took high yield from the bottom tenth of its range to the middle, and it has held the middle rather than making a new extreme.

That is the difference between last Thursday and today. Then the series had done nothing but widen for 6 sessions. Now it has widened and given most of it back.

Investment grade never moved

Investment grade OAS is 0.83% (as of 6 Oct), from 0.84% (29 Sep) - 1 basis point tighter. Across the whole sequence it has not left 0.83%-0.86%: 0.84% (29 Sep), 0.84% (30 Sep), 0.86% (1 Oct), 0.85% (2 Oct), 0.84% (5 Oct), 0.83% (6 Oct).

Investment grade sits at the 43.2nd percentile of its own history, high yield at the 50.2nd. The two rungs are still within 7 percentage points of each other on rank.

A widening that never reached investment grade and has been retraced in high yield is a move in the lowest-rated tier, on its own. It is not a re-rating of the whole credit complex, which is what a default cycle looks like from here.

The funds bought the retracement

HYG is 77.18 (7 Oct close), down 0.09 on the day but up 0.312 on the week. JNK is 92.76, down 0.12 on the day, up 0.541 on the week. LQD is 102.10, down 0.04 on the day, up 0.359 on the week.

Last Thursday all three were falling against a widening curve. This week all three are higher on the week: the fund market has taken the same side as the spread, not the other one.

A high yield fund that trades up while its own index spread is 5 basis points wider than a week ago is buying the retracement in the cash market. The listed market is not waiting for the spread to finish.

The long end repriced again, and spread did not follow

The 10yr closed at 5.277% (as of 7 Oct), +0.8bp on the day. Over the week it is roughly where it was: -1.6bp from 5.293% on 30 September. The move is in the tails, not the belly: the 30yr is 5.661%, +2.0bp on the day and +2.3bp on the week, and the 20yr is 5.71%, +3 basis points on the day.

The 30yr and the 20yr both sit at the 100.0th percentile of their history. The 10yr is at the 98.2nd, the 5yr at the 96.4th, the 7yr at the 97.6th. Every tenor from 5yr out is in the top few percent of its own range; the 2yr is at the 83.7th and the 3M at the 31.6th.

That is a repricing of duration risk, and credit has absorbed it. High yield tightened 5 basis points through a week when the long end added 2 to 3 and sat at its own record. A spread index that falls against a rising long bond is not pricing a credit event.

Rate vol fell, equity vol is at the floor

MOVE is 102.56 (7 Oct close), down 7.89 on the week, percentile rank 55.6 - the middle of its range after a sequence in the 60s. VIX is 15.08, up 0.07 on the day and down 1.26 on the week, percentile rank 8.0 - the bottom eighth of its history.

The S&P closed at 7,801.77, down 17.16 on the day and up 150.23 on the week, rank 99.5. The QQQ is 757.73, down 1.93 on the day and up 17.96 on the week, rank 99.5. Equity is at the top of its range while credit vol and equity vol both read calm.

Rate volatility coming off a sequence high into a credit retracement is the surface agreeing with the spread. There is no stress being priced in either volatility market.

The cash flow is still the low end

Initial claims were 197,000 in the week to 26 September, from 198,000 in the week to 19 September (as of 26 September). Continuing claims were 1,701,000 in the week to 19 September, from 1,712,000 in the week to 12 September (as of 19 September).

Both are at the bottom of their own history: initial claims in the 2.3rd percentile of the series back to 1967, continuing claims in the 11.0th. Initial claims have not printed above 200,000 since the week to 5 September.

Spreads retrace before defaults are visible - defaults are the last thing in the sequence. Nothing in the labour data is pricing a credit cycle, and the spread has stopped trying to price one either.

The plumbing is quiet underneath

Secured overnight funding is 3.90% (8 Oct, NY Fed) against an administered rate of 3.90% (8 Oct) - the spread is zero. RRP take-up is $2.3bn (7 Oct), from $0.4bn (6 Oct). Reserve balances are $2,948.1bn (as of 30 September), unchanged across the fortnight.

The Treasury general account is $885.4bn (as of 7 October), from $871.2bn (as of 6 October) and $984.0bn (as of 2 October) - rebuilt $14.2bn on the day after the $112.8bn drain the last 2 sessions described.

Core CPI is +3.71% y/y on the August print (as of 1 August). A credit market that has retraced its widening, with funding inside the administered rate and reserves flat, is not being moved by collateral or by cash.

What would settle it

Confirmation of the calm is straightforward: high yield holding inside 2.95%-3.10% with investment grade under 0.86%, the funds staying bid, and claims under 200,000. That is the compression trade intact, having absorbed a long-end repricing it has now shrugged off twice.

The first invalidation is the widening resuming: high yield back through 3.24%, the 1 October peak, with investment grade following through 0.86%. That would say the retracement was the pause and the 1 October print was the direction.

The second is a break in rank rather than in level: high yield back under the 25th percentile of its own history, near 2.85%, would put it back in the bottom quarter where the compression trade started - a different market from the one trading at its median.

The composite headline is 0.351 in a TIGHTENING regime on 5 of 5 sub-indices, with Rates & Policy dominant at 1.66 and Credit & Stress the mildest contribution at -0.149. The index that measures this complex reads the same thing the spread does: the stress is in the price of duration, not in the price of default.