Stage III · The Tape · STEP 8

Credit and stress

Credit spreads are the market's price of doubt. Where the crack shows first is almost always credit, not equities.

Why this matters

A credit spread is the extra yield a risky borrower pays over a safe one. It is the market's price of default risk, quoted in real time. HY OAS — the option-adjusted spread on high-yield bonds — is the number to watch; the higher it goes, the more doubt is being priced.

Credit usually cracks before equities do, because a bondholder's upside is capped and their downside is not. When the equity index is calm and spreads are widening, the bond market is telling you something the stock market has not yet accepted.

The trap is the percentile. A spread at the 20th percentile of its three-year range sounds comforting until you check where the range started. What a percentile hides is a lesson of its own, and it is the one that stops you being fooled by a 'cheap' market that is only cheap against a stressed recent past.

Watch

Macro Voices ↗
Where rates, liquidity and credit meet, discussed by practitioners who allocate against them.
Forward Guidance (Blockworks) ↗
Sharper and faster on the credit and macro trade; a good complement once the concepts are familiar.

Read — our own explanation

Verify at the source

BEFORE YOU MOVE ON

You can read a HY OAS level as a price of default risk, and say why a percentile can mislead about how much room is left.

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