The NY Fed recently unveiled its Corporate Bond Market Distress Index (CMDI), a metric that reflects the health (or distress) in US credit market functioning. It is a broad measure that does not only look at credit prices, but also primary and secondary market transaction volumes, as well as liquidity. These separate indicators are combined using optimization techniques to elicit a systemic component of market functioning. Due to limited data access, market functioning is hard to track, and the NY Fed’s provision of the CMDI is a welcome development that improves transparency significantly in credit markets.
On a headline basis, the CMDI index is showing normal levels of market functioning. However, it is unsettling to find that that the CMDI is now rising very sharply for the most important and largest credit segment, namely the IG market. The level of distress (or dysfunction) appears to be the worst since the early months of the pandemic. What could explain the poorer market functioning for US IG, compared to HY credit?
One factor may be due to higher and more volatile bond fund outflows. Indeed, the US-based ICI has estimated 5 consecutive weeks of outflows from bond funds since late May, with outflows further accelerating after the June FOMC meeting. While having a large impact on IG credit, such flow dynamics tend to be less critical for HY markets, as prices/transactions depend more on idiosyncratic firm-level risks. A second factor could be that IG credit has a larger exposure to duration risks compared to HY, since HY offers a greater spread buffer for returns while also having shorter tenors in general. Certainly, growing Fed hawkishness and a more consistent guidance for larger rate hikes are diminishing the allure of longer-tenor IG credit, while tempering the search for yield as rates soar. Notwithstanding these factors, we still see duration-hedged US IG credit to be attractive with an adequate discounting of slowdown risks.