Market Insider

Tesla bonds blowout is a warning for risk, credit

Key Points
  • Tesla's bond blowout is not symptomatic of wider problems in the credit markets but it does come as anxiety is rising over risk assets and in some parts of the credit world.
  • While the moves in credit market represent some risk aversion, analysts say it's more smoke than fire at this point.
  • Libor, the rate at which banks lend to each other, has been creeping up and has in the past represented credit risk. But analysts say the move is largely technical.
Options traders are pumping the brakes on Tesla

Tesla's bond yields blew out to record highs Wednesday on the electric car maker's own set of problems, but analysts say it highlights signs of worry that have been creeping across markets.

Analysts pointed to the explosion of volatility in stocks, where the Nasdaq has had 2 percent moves in four of the past five sessions. High yield and investment grade corporate bond spreads have widened, and investors have rushed back into Treasurys, driving yields lower. At the same time, Libor, a barometer of credit fear during the financial crisis, is ticking higher.

All of this comes as the markets approach the end of the quarter, which could be exacerbating moves. While analysts say there may be more smoke than fire, the swings in the stock market are creating anxiety across markets. Issues like Tesla don't help.

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"Tesla's still a poster child for speculation in this bull market. If people are going to have a more discerning eye on Tesla, they're going to have a discerning eye on a lot of other credits," said Peter Boockvar, chief market analyst at Bleakley Financial.

Boockvar said there has been a widening in high-yield spreads since early February, but only to about 355. They had been as wide as 840 basis points when oil prices fell in 2015 and 2016, creating havoc for energy company bonds. Spreads are the difference between the yield on the high-yield corporate index and the comparable Treasury yields.

Tesla 2025 bond

Tesla bonds were downgraded by Moody's to B3 from B2, which also changed the outlook to negative from stable due to the significant shortfall in the company's Model 3 production rate. The 2025 Tesla bond was yielding around 7.7 percent Wednesday, up from 6.80 percent Tuesday. Yields move opposite price. Tesla stock plunged 7.7 percent Wednesday.

Andrew Brenner of National Alliance said Tesla's bond is not indicative of problems for other issuers, but there is a bit of concern around credit.

"It's a signal for other risk assets that you have to be aware of the cash flows of the companies you're buying," said Brenner. "While Elon Musk may be taking us to Mars and everywhere else, he still has to come up with cash."

The widening of spreads between corporates and Treasury yields is no where near fire alarm levels of past years, but it is a creep up in recent weeks that analysts have been monitoring.

"I think it's indicative of a greater risk aversion," said Boockvar.

The move is evident in LQD, the iShares 10+ Investment Grade Corporate ETF and HYG, the iShares iBoxx $ High Yield Corporate Bond ETF, both of which have declined since the start of February. LQD was slightly higher Wednesday, while HYG was lower.

"What it means is there's a lot more volatility going on in the corporate space. People are taking money off the table. People are a little more concerned about risk assets. If you look at an options adjusted spread for investment grade [corporate debt] at the beginning of the month it was 88, today it's 102. It's widened 14 points," Brenner said.

On Wednesday, Treasury yields at the long end moved lower, with the 10-year back to 2.77 percent, after breaking the key support at 2.80 percent Tuesday.

Ian Lyngen, head of U.S. Treasury strategy at BMO, said the move is reflecting the fading of optimism and the volatility in stock prices. But the move in Libor has been nagging at markets, even though it is being dismissed as technical.

"It's the spread between Libor and OIS which people care about because that implies there's a certain amount of risk in the credit system. The divergence between Libor and the implied fed rate has increased dramatically," he said. "It affects a lot of corporate borrowing. It's the reference floating rate for everything."

Libor is the London interbank offered rate, the level at which banks lend to each other.

Brenner said at the beginning of the year, 3-month Libor was at 1.69, and it's moved out 61 basis points since then. "We've only had one Fed rate hike. It's moved out by 61 and you only have a 25 basis point hike," he said. "Corporations have $2 trillion of Libor-based floating rate debt, so that's costing them money."

Analysts have said the move in Libor, however, is not sending the alarms it did when it shot up sharply during the financial crisis. They blame the jump in Libor on two factors: A much higher amount of short-term Treasury issuance and the fact that U.S. companies are bringing their overseas cash home, some of which was held short term securities.

"There's more competition for some of this shorter dated issuance. That went for bills, or commercial paper, and there's less demand for it because what were typically investors in those types of securities or paper, namely these firms that were investing their offshore earnings are no longer doing that to the extent they were," said Jonathan Duensing, director investment grade corporates at Amundi Pioneer.

"It's an decrease in demand matched up with an increase in supply that's pushed up the cost of money in short term funding markets. Traditionally, investors have looked to those short term funding markets as for signs of stress in the financial markets. I think you could call a supply demand imbalance a little bit of stress. It's not like bank A doesn't trust bank B," he said.

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