Market Overview

Energy High-Yield Default Risk Is At Its Highest Level Of 2015

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Energy High-Yield Default Risk Is At Its Highest Level Of 2015
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Global equity markets experienced another brutal day on Monday, as a massive selloff in the Chinese stock market spooked investors worldwide. Weakness in China, coupled with low oil prices, have sent default probabilities of high-yield energy bonds soaring to their highest levels so far this year.

Why Does China Matter?

Not only is China the second largest global economy, it is the single largest consumer of raw materials. Demand from China is a key element of the equilibrium in equity and commodity markets all over the world, including the oil market.

China’s 8 percent stock market sell-off on Monday was its largest one-day drop since the global Financial Crisis. Much of the selling is likely in response to last week’s weaker-than-expected manufacturing data out of China, which was particularly troubling for the already oversupplied oil market.

WTI crude oil prices fell to new six-year lows on Monday and are now trading below $39/bbl. The United States Oil ETF (NYSE: USO) is down more than 6 percent to 12.37 on Monday, a new all-time low.

Other Commodities

It’s not just the oil market and the stock market that were under pressure on Monday. Copper and aluminum prices also hit their lowest levels since 2009, and iron and steel prices are also crashing.

Coal futures are now trading at 12-year lows in response to Chinese weakness, and the Market Vectors Coal ETF (NYSE: KOL) has dropped to new all-time lows as well.

Bond Risk Grows

The extreme commodity weakness has energy bond holders holding their breath. According to data from Friday August 21, the 12-month default probability of high-yield energy bonds climbed to 11.9 percent.

As the graph above shows (sourced from FridsonVision LLC, BofA Merrill YNCH Global Research and used with permission; Moody’s Investors Service), the market-implied default rate for high-yield energy bonds has nearly doubled in only three months from 6.4 percent in May.

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