Yahoo Finance 
DEUTSCHE BANK: A wave of defaults may be just around the corner
(Andrew Burton/Getty Images)
The credit markets have been showing signs of contagion, as Chinese growth concerns and slumping commodity prices lead to widespread selling.
That has Deutsche Bank wondering if there is likely to be a wave of companies failing to pay interest on their bonds.
It said in a note Friday: "With the recent back-up in both IG [investment grade] and HY [high-yield] spreads to their respective 3.5-year wides, a discussion has emerged about whether the market is sensing the next default cycle around the corner or is simply “overreacting” to some exogenous but ultimately irrelevant events. At 570bp ex-energy spreads, the market is well ahead of what would normally be considered sufficient compensation for defaults that are still tracking sub-2% in this segment of our markets."
Strategists Oleg Melentyev and Daniel Sorid looked at six leading indicators to judge whether the credit market has over-reacted, and found that two are flashing red - meaning they are "at levels consistent with where previous credit cycles have started."
The two signals flashing red are volatility shocks, and spreads on the highest rated corporate bonds. As the chart at the bottom of this page shows, the Vix and spreads on AA-rated corporate bonds are moving in a similar fashion to the late 90s and the years leading up to the financial crisis.
Two other indicators - financial stocks and monetary policy - are flashing yellow, meaning they have shown some signs of deterioration but are not yet at stressed levels. Two other indicators - volatility in Treasuries and issuer fundamentals - are sending no warning signals.
"So where does all of this leave us, in terms of our outlook for the timing of the next default cycle, and perhaps more specifically, our outlook for default rates next year?" Deutsche Bank said in the note.
"Our view is that default cycle is likely to be closer than consensus seems to believe, and its early stages may arrive as soon as next year, although at this point there is not enough evidence to make it a base case scenario, so we are keeping it as a risk to our outlook."
The strategists forecast a 5% default rate for the high-yield market by 2016, and expect commodity-related sectors to enter "a full-scale default environment by next year", with default rates moving from 7.6% to 12%.
(Deutsche Bank)
NOW WATCH: This is the Excel trick that will change everything about how you work with data
More From Business Insider
