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Oil down but junk bonds over it?

The correlation between moves in the oil price and equity markets are becoming increasingly concerning and do not bode well for today’s Asia session.

Oil
Source: Bloomberg

Japanese markets will be closed, and the ASX looks likely to fall short of meeting the 5411 level where it began the year.

Of course, as mentioned yesterday, in total return terms the ASX 200 will actually finish up 4.6% with dividends reinvested and Aussie SMSF investors can hopefully ring in the New Year on a positive note after the Santa Rally of the past two weeks.

BHP’s ADR is currently pointing to 1.4% decline at the open, while CBA’s ADR is relatively unchanged. The fortunes of the ASX’s last session for the year will largely be driven by the banks today, and whether the yield hunters come out buying. With any luck, strong buying in the rest of the index may help outweigh the inevitable drag that we will be seeing from the materials and energy space.

Oil

EIA oil inventories unexpectedly expanded overnight by 2.6 million barrels when markets were expecting a decline. Of course, predictions for the EIA weekly oil inventories number are notoriously unreliable and are akin to a coin toss, personally it’s an area where I would favour the services of Paul the Octopus. This saw a more than 3% drop in both Brent and WTI. Predictably, this saw the energy sector lose 1.5% on the S&P 500 and drive concerns in the whole market. However, unusually this weakness did not carry over into the two main high-yield ETFs, HYG and JNK, which were both largely flat on the session. It’s a bit early to infer too much into this, but it would not be surprising that much of the oil price weakness has now been priced into junk bonds. If that is the case, we could be approaching the turning point for junk bonds, perhaps foreshadowing a much better year ahead in 2016. Some good news perhaps for recent entries in the junk bond market such as Noble Group.

Potential default by Puerto Rico

The other growing concern for junk debt is the likely default by Puerto Rico on its US$70 billion of debt on 1 January. US$1 billion is due on that day, but it’s in doubt whether the government will even be able to make its US$330 billion payment on “general obligation” bonds, which many creditors had believed unlikely due to its constitutional guarantee. Of course, there has been plenty of forewarning about a potential default by Puerto Rico. But the concern is that the rising defaults in emerging markets, in the energy and materials space and now from Puerto Rico (a semi-sovereign), could all combine together in unforeseen ways that could see counter-party risk premiums rise and significantly raise global cost capital, potentially leading to more defaults.

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