Traders Rush to Hedge Against Increasing Market Volatility

Credit Market Risks Mounting Amid War in Iran and Weakening US Jobs Market

The US and European credit markets are facing growing risks, with some investors and strategists recommending the purchase of credit default swap protection to hedge against potential market downturns. Barclays strategists suggest buying protection on the US High-Yield Index, recommending a combination of trades known as a payer swap to help pay for the trade.

The cost of buying protection on US High-Grade Corporate Bonds climbed nearly 0.03 percentage point, or 3 basis points, this week, despite spreads on cash bonds narrowing by 1 basis point. This signals that market players are turning to derivatives for protection against credit risk, while in company bonds, they are not selling bonds to a degree that would imply more concern about corporate defaults.

Andrew Weinberg, portfolio manager at Saba Capital Management, notes that there needs to be a material catch-up between the risks in private capital and geopolitics and the risks being reflected in high-grade corporate bond spreads. He believes this is a good time to be looking at credit hedges.

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The ongoing war in Iran and its impact on the oil market are contributing to higher inflation, which has helped lift yields in bond markets globally. If the Federal Reserve eventually has to start boosting rates, credit could get hit, according to JPMorgan Chase & Co. strategists.

The US jobs market is also weakening, with employers unexpectedly cutting 92,000 jobs in February, raising questions about consumer spending growth in the coming months. Artificial Intelligence could also trigger layoffs, potentially eliminating employment in whole businesses.

Investors are pulling money from some private credit investments, and bullish bets in credit default swap indexes have been eroding over the past few weeks amid anxiety over the software sector. Some money managers have been cutting their risk for months as valuations have climbed and potential problems have been growing.

DoubleLine Capital had its lowest-ever allocations to speculative-grade bonds in June, and Ryan Kimmel, fixed income allocation strategist, believes that the company is in a position to snatch up bargains if they arise. Christian Hoffmann, portfolio manager at Thornburg Investment Management, notes that investors can still reposition for risks that appear skewed to the downside and that recent geopolitical events, along with AI, software, and private credit, are increasingly interconnected.

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