Signals are flashing red in the structured credit market, according to Bank of America.
Credit analysts at the bank are warning that structured credit products are entering a new “risk-off” phase as a number of market indicators imply caution is warranted.
“We turn more defensive on securitized products and underweight on agency” mortgage-backed securities, BofA analysts including Chris Flanagan and Alexander Batchvarov wrote in a note. “Risk-off phase likely has started.”
The diminishing appetite for risk among investors should spill into wider investment-grade corporate spreads. That will likely bleed into higher-rated structured products, such as mortgage-backed securities from Fannie Mae and Freddie Mac. The bank remains neutral across the rest of the sector.
Key indicators of the trend are the 10-year Treasury yields, the spread between two-year and 10-year Treasuries, rate volatility and investment-grade corporate spreads. The BofA analysts also said that U.S. stocks appear to have peaked compared with the Shanghai Composite Index, and mean reversion shows this may be the start of underperformance of American equities versus Chinese counterparts.
“All of these appear likely to have turned in recent weeks, and are now poised to extend moves in the most recent direction,” the analysts wrote in the Aug. 10 note. “August should provide good conditions to tactically position for curve flattening, lower rates and wider spreads.”
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