Bond Outlook [by bridport & cie, May 18th 2005]
| When bond spreads widen, equities are "supposed" to fall, but, instead, they have been volatile but roughly holding their own. This means that the traditional hedge fund move of going long on corporate bonds and short on stocks has failed to deliver. Such is one explanation, probably simplistic, of poor hedge fund performance of late. Others include losses on "payment-in-kind" bonds and the end of convertible arbitrage. The cost of protection against credit default has sharply risen, and spreads on all types of bonds have widened. Liquidity in high-yield bonds is very low, despite their default rate also being very low. It is as if fixed-income markets fear that high-yield performance has been too good to last. That has been our view for several weeks. |
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| We confess to believing that the trigger for spreads widening would be long-term Treasury yields climbing under the menace of inflation. In fact, doubts about high-yield bonds is setting in independently of long-term Treasury yields and may be linked to structured product and hedge fund problems, including redemptions (hence forced selling) after recent losses. |