The Tell: Oil topping $125 a barrel could break this part of U.S. credit market, warns BofA
Cracks in the U.S. high-yield corporate bond market could form if Russia’s assault on Ukraine pushes already-high $100 oil prices up another $25 a barrel, warns BofA Global’s credit research team.
Higher energy costs already have been pinching U.S. consumers and businesses as Russia’s invasion of Ukraine enters a third week, sparking a U.S. ban on its oil imports and a push Friday to further limit American and European trade with Moscow.
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While the U.S. takes in only about 10% of Russia oil exports, the European Union’s share is closer to 25%. “If you add up all countries of the Western coalition, we are looking at roughly 50% of Russian oil exports,” Oleg Melentyev’s team at BofA wrote, in a Friday note.
Should Russia opt to “cutoff that share, as was recently contemplated by Kremlin officials,” markets could be facing oil at $150 to $200 a barrel, they wrote. “This could cause a major negative impact on consumer spending, manufacturing, and credit conditions in the US and EU.”
On Friday, U.S. oil prices
were near $109 a barrel and Brent crude
the global benchmark, was near $112 a barrel, both heading for weekly losses after earlier in the week touching their highest levels since 2008.
The BofA team studied when sharp increases in oil prices tend to dampen business activity. They found manufacturing and services tend to dip when oil rises 50% from its last three-year average.
“If we end up averaging $100 oil in the next few months, the increase is going to be on the cusp of +50% from last-3yr averages,” the team wrote. “If we go consistently above $125, the increase will push us meaningfully beyond the threshold where sensitivities get much stronger.”
In other words, things could get a lot trickier for U.S. companies reliant on the near $1.7 trillion high-yield, or “junk-bond,” market. The commodity shock since Russia’s Ukraine incursion has sparked volatility and led new issuance to dry up.
See: Junk-bond issuance pauses as Russia threatens Ukraine, with spreads at their widest level in a year
Junk-bond spreads have climbed about 1% since the start of the year to about 4 percentage points above Treasurys, according to the ICE BofA US High Yield Index. Spreads are the premium investors earn above a risk-free rate to compensate for credit and default risks.
With oil at $125 a barrel, the BofA team thinks high-yield spreads may increase to 5 percentage points above the risk-free rate, and 6 percentage points over the benchmark with oil north of $150.
“Hence the scenario where Russian oil stops flowing to the EU and potentially other allies in Asia represents the key risk to credit, since it implies major negative impact on economic activity and a potential for meaningful tightening in credit conditions.”
U.S. stocks were headed for weekly losses, with the Dow Jones Industrial Average
down 1% through Friday, at last check, and the S&P 500 index lower by 1.7%. The biggest U.S. exchange-traded junk-bond funds
were down at least 6.6% for the week, according to FactSet.
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