The credit market is sending one of the most alarming signals in decades. For the first time since 1998, primary dealers have taken a net short position on corporate bonds. This involves a volume of approximately $4 billion for the current year. This means dealers have sold more credit risk than they actually hold on their balance sheets.
For comparison, in 2017, the same banks held an average of $16 billion in such securities at their peak. The shift from a large long position to a short one is an extremely telling moment that deserves close attention.
What is behind this reversal?
Analysts highlight several possible reasons for this scenario. Either banks fear a weakening of the credit market, or demand for bonds is too high to keep them in reserve. A third option is that electronic trading has simply eliminated the need for such reserves.
The bulk of the short positions are in long-term debt — $13.7 billion in securities with maturities of five years or more. This position is partially offset by a long position of $9.66 billion in shorter-term issues. It is long-term securities that are most sensitive to rising yields, so dealers are exercising maximum caution with them.
At the same time, credit spreads are holding near multi-year lows. This means that dealers receive extremely meager compensation for taking on credit risk. A potential bounce poses a particular danger. If bonds start to rise, dealers may be forced to cover short positions in a market with almost no supply, turning a comfortable position into a rapid and sharp reversal.
Parallels with the stock market
This alarming signal is unfolding against the backdrop of an unusual picture in the stock market. Estimates suggest that profits of companies in the S&P 500 index could grow by 24% this year. The market has not seen such high rates outside of post-recession recovery periods. Analysts call this an "unprecedented boom," fueled by a sharp increase in earnings per share at major technology companies.
Both pictures complement each other. Record optimism in stocks and near-zero compensation for credit risk point to one thing: the market is extremely underestimating the likelihood of problems. This is precisely what makes it vulnerable to a sharp reversal.
Cryptalist Commentary: Historically, the credit market cracks before the stock market. The current situation is a classic signal that the market is overheated and is not pricing in risks. For crypto investors, this is a reason to monitor macroeconomic indicators more closely: if a flight from risk begins, digital assets could come under pressure first.