(Bloomberg) — War in Iran. A weakening US jobs market. Artificial intelligence and the potential demise of whole industries. Growing pressure on private credit.
The risks in US and European credit are piling up, and some investors and strategists think it’s time to buy protection against the market tanking while such hedges are still relatively cheap.
Barclays strategists this week recommended buying credit default swap protection on the US high-yield index. To help pay for the trade, the bank suggested selling some protection that is less likely to pay out, a combination of trades known as a payer swap. Morgan Stanley suggested similar trades recently.
Suggestions to hedge seem to be gaining traction. The cost of buying protection on US high-grade corporate bonds climbed nearly 0.03 percentage point, or 3 basis points this week, even as spreads on cash bonds narrowed 1 basis point. That signals that market players were turning to derivatives for protection against credit risk, while in company bonds, they weren’t selling bonds to a degree that would imply more concern about corporate defaults.
“There needs to be a material catch-up between the risks the market is worried about in private capital and geopolitics and the risks being reflected in high grade corporate bond spreads,” said Andrew Weinberg, portfolio manager at Saba Capital Management. “This is a very good time to be looking at credit hedges.”
The US and Israeli war in Iran is showing few signs of abating, and in the oil market, investors are pricing in a prolonged conflict. The rising price of oil could translate to higher inflation, which has helped lift yields in bond markets globally.
Any sign of higher inflation could spur the Federal Reserve to slow its pace of easing. If the US central bank eventually has to start boosting rates, credit could get hit, JPMorgan Chase & Co. strategists wrote in a Thursday note.
At the same time, employers in the US unexpectedly cut 92,000 jobs in February. The pain was visible in a wide array of industries, not just one or two, raising questions about how strong consumer spending growth will be in the coming months. Artificial intelligence over time could also trigger layoffs, potentially eliminating employment in whole businesses. Fearful investors are pulling money from some private credit investments.
Bullish bets in credit default swap indexes have been eroding over the past few weeks amid anxiety over the software sector, according to DTCC data analyzed by Barclays Plc. The weekly data doesn’t yet reflect the impact of war in Iran, though a jump in CDS index spreads amid high trading volumes suggests the positioning shift is ongoing.
Some money managers have been cutting their risk for months as valuations have climbed and potential problems, including geopolitical tension and possible economic slowdowns, have been growing. DoubleLine Capital, for example, said in June it had its lowest-ever allocations to speculative-grade bonds.
“We don’t want to be in a position where we have to be reactive during a market downturn,” said Ryan Kimmel, fixed income allocation strategist at DoubleLine on Friday, adding that the company is instead in a position to snatch up bargains if they arise.
For now, investors are far from panicking. The cost of credit default swaps has risen in recent weeks, but is still below even levels in April 2025, when the market was concerned about Trump’s liberation day tariffs. Risk premiums in cash bonds over the last month have only edged higher.
That lack of panic may offer a good opportunity to cut some risk.
“Investors can still reposition for risks that appear skewed to the downside,” said Christian Hoffmann, portfolio manager at Thornburg Investment Management. “Recent geopolitical events, along with AI, software and private credit, are increasingly interconnected. That’s likely to create clearer winners and losers.”
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