Goldman Sachs warning: The current market is just "unstable stability," and credit "cockroaches" are more frightening than crude oil.

As Middle Eastern tensions shake up the commodity markets, a more worrisome divergence is quietly unfolding in the credit markets. The Goldman Sachs credit strategy team has issued a warning: beneath the outward calm, undercurrents are rising, and this “steady state” is intrinsically unstable.

Compared to the volatility in equities and commodities, the credit markets have displayed unusual resilience over the past three weeks—stocks have only dropped around 5% from historic highs, and credit spreads have widened only modestly.

However, Goldman strategists Reid Zhou and his team believe, the market is transitioning from a “shock pricing” phase to an “economic impact” pricing phase, and the current peace is more like a standoff than true stability.

Notably, the chief pressure in the credit market does not originate from the energy sector, but is concentrated in the financial sector, especially institutions linked to private credit. Bonds related to Blue Owl, FS KKR, and private credit funds have performed the worst, with spreads on financial bonds expanding by 39 basis points year-to-date.

This signal increases market vigilance: behind the noisy swings in oil prices, the “cockroach effect” of private credit may be a deeper concern.

Credit Divergence: Financial Sector Pressures Far Exceed Energy

According to Bloomberg, the expansion of US credit spreads started before the outbreak of this Middle Eastern conflict, and this wave of credit sell-offs has been characterized by remarkable consistency across industries and ratings.

The only exception is not energy but finance. The spreads on corporate bonds of financial service companies have expanded by 39 basis points this year, with issuers linked to Blue Owl, FS KKR, and private credit funds showing the weakest performance.

The credit performance of the energy sector has actually been relatively strong this year, but its superior performance was mainly concentrated in February—before the conflict broke out. This is in sharp contrast to the stock market: in equities, the energy sector has notably outperformed other sectors since the conflict began.

Specific data shows that, in BBB-rated US dollar bonds, the spread difference between energy and financial sectors was only 2.4 basis points at the start of the year, expanded to 13.5 basis points before the conflict broke out on February 26, and has now further widened to 18.5 basis points. The ongoing pressure on private credit is becoming the most dangerous variable in the entire credit market.

“TACO Game”: Market and Policy in Mutual Watchfulness

The Goldman Sachs team summarizes the current market deadlock with the “chicken or egg” question.

The market uses “TACO” (Trump Always Chickens Out) as an expectation anchor, which is why there has been no large-scale sell-off; meanwhile, policymakers are holding steady because the market has yet to experience major turmoil.

Goldman notes: “We are in an extremely delicate steady state, but the backdrop is highly unstable—a game where whoever moves first loses.”

The strategy team believes the duration of this steady state may exceed expectations, but it will ultimately be transitional. Market volatility in interest rates has quickly climbed from the historical 10th percentile to near the 70th percentile, reflecting swift digestion of shocks; however, spread widening remains restrained, and capital flows essentially balanced.

Triple Fragility of the Steady State: Capital Flows, Positions, and Irreversible Damage

Goldman dissects the inner fragility of the current steady state from three angles.

First, fundamental support remains, but position pressure is accumulating. The basic credit fundamentals still offer support, new bond issuance is being fully absorbed by the market, and total-return buyers remain active. At the same time, CTA strategies have de-risked, and some hedges have been unwound, alleviating valuation and position crowding. However, this means that when the next round of risks hits, investors’ protective buffers will be thinner.

Second, risk of outflows from high-yield bonds is heating up. Signs of capital outflows from high-yield bonds have recently emerged, and if these continue, credit beta will accelerate its downward attachment. Goldman highlights that with prior hedges unwound, vulnerability to a new round of spread expansion is rising.

Third, some damages are irreversible. Even if there is a future policy concession, the credit market will not simply return to its pre-conflict state. Goldman believes that any interim rebound will likely be gradually digested over the medium term, although the process will unfold in a controllable manner rather than a rapid reversal.

Goldman's Trading Strategy: Short the Basis, Sell Volatility

Based on these judgments, the Goldman credit strategy team gives specific positioning recommendations.

First, shorting the spot-futures basis (long futures, short spot) is considered an optimal strategy for multiple scenarios: If there is a short squeeze rally, the futures side—with leverage squeeze—should outperform the spot (basis narrows); if spreads enter a second round of widening, forced spot selling will weigh more on spot than futures (basis also narrows).

In terms of specific products, Goldman prefers high-yield bonds to investment grade bonds. The team suggests a reference combo: short the GS2BATAS high-yield BB basket swap, and long CDX HY45. Compared to building a short position by short selling HYG, using basket tools offers lower shorting costs.

For volatility, Goldman continues to favor selling credit volatility, which can be achieved via at-the-money straddle or STS strategies. Given volatility has recently surged from below the 10th percentile to near the 70th, the team leans toward combining spot long gamma positions with directional options instead of pure straddles, to control costs while capturing non-linear returns.

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