Aegon, Barclays Say Prepare for Market Pain

v5wjsys45nbs78bjqkc6tcft_media_dl_1.png DTCC data compiled by Barclays

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(Bloomberg) — Skeptics including Aegon Asset Management and Barclays Plc are getting ready for April’s credit rally to potentially vanish as quickly as it appeared.

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Global investment-grade credit logged its best month since August and high-yield, its best since 2023, returning 1.3% and 2.3% respectively. Investors are broadly betting that the war in the Middle East is over, and earnings in the US have so far been strong, spurring what Barclays strategists called a “don’t worry, be happy” market. 

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But this week, crude oil prices hit a four-year high and Treasury yields climbed sharply on the threat of rising inflation. The Strait of Hormuz remains effectively shut. 

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Few of the risks that brought fear in March have fully disappeared. Some investors and strategists suggest buying credit default swaps on the market, or purchasing shorter-term debt, to protect against a potential downturn. 

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“We think spreads will sell off but we don’t know when,” said Alex Pelteshki, a portfolio manager at Aegon Asset Management, who is looking at collecting yield in shorter-dated bonds as a defensive position. 

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The Strait of Hormuz has become a focal point for geopolitical — and inflation — risks. Traffic through the waterway has been at a near-standstill since the US and Israel launched strikes against Iran in late February and Tehran threatened to attack ships in the strait. Consumers are already starting to feel the pinch from rising energy and transport costs. Central banks previously seen as likely to cut interest rates this year are now in limbo as they watch for signs of resurgent inflation. 

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“It doesn’t seem like there will be material flow of things flowing through that strait. Not just oil, but also fertilizers, what have you,” Aegon’s Pelteshki said. 

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Hedging is relatively cheap. The five-year CDX North American Investment Grade index traded at around 54 basis points on Friday, meaning hedging $10 million of principal would cost around $54,000 a year. In late March, it was closer to 68 basis points. 

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In the weeks after the war in Iran broke out, investors had ramped up protective hedges, and briefly turned short risk in their positioning in the iTraxx Main index, according to Barclays. Some investors are keeping their hedges in place now. 

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“We’re kind of waiting and seeing what’s going to happen, if the war restarts or if the Strait remains closed,” said Felipe Villarroel, portfolio manager at Twentyfour Asset Management. He boosted his hedges using the iTraxx Crossover credit-default swap index at the start of March — a position he continues to partly hold. 

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By late March, the move had reversed on bets that the worst of the war in the Middle East was past — and positioning is now long versus history, according to Barclays.