If an oil-driven inflation surge forces monetary policymakers to tighten super-loose credit, then assets most exposed to the waves of central bank liquidity run aground.
And frothy junk debt -- high-yield corporate bonds with sub-investment grade credit ratings -- could be prominent among the wreckage.
The scramble for some real, inflation-adjusted, yields has sent investors flocking to the sector for over a year. So much so that average yields, according to Credit Suisse data, have been dragged down to record lows below 7 percent -- lower even that the heady days of the credit boom between 2005 and 2007.
And new junk sales are booming. ThomsonReuters data shows global junk issues so far this year of $56 billion, a 74 percent increase over last year. February is set to be the eighth consecutive month with over $20 billion in new junk debt sold -- the longest stretch since records began in 1980.
Fund trackers EPFR show demand for high-yield bond funds -- which drew net inflows of over $30 billion in 2010 -- continued at a record pace this month and an excess of $2 billion flowed to these funds in the fortnight through February 16.
Given all this was fueled by super-loose monetary policy, sovereign risks and a junk default rate that last year fell below 1 percent -- two percentage points below historical averages -- then a withdrawal of central bank liquidity that slows world growth should be alarming.
"Behavioral traits that characterize all bubbles should be borne in mind," Ted Scott, director of Global Strategy at F&C Investments, told clients this week.
"The next candidate for the bubble is in sub investment grade and junk bonds where issuance is already rising rapidly," wrote Scott. "The trend in high yield and junk bonds should be monitored closely."
FEAR OF INFLATION BACKLASH
Financial bubbles typically let asset prices drift far from fundamental valuations and become a speculative pass-the-parcel that persists for as long as the music keeps playing.
The only real puzzle -- whether in the 'tulip mania' of the 1620s, the dotcom frenzy of the 1990s or the Irish real estate spiral over the past decade -- is figuring out when the volume switch will be flicked off.
It typically takes some external trigger to make investors rethink valuations.
The biggest fear for those loaded up on this paper is a bout of high inflation that forces central banks to belatedly and grudgingly lift interest rates and a resulting stagnation of the underlying economy -- 'stagflation' to the economics wonks.
Rising food prices and accelerating inflation in the world's developing economies have already raised the red flag among monetary policymakers from the European Central Bank to the Bank of England and the U.S. Federal Reserve.
Futures markets already see ECB and UK rate rises this year and are half priced for one from the Fed too by December.
The fact that surveys of private sector business across Europe and elsewhere continue to show booming activity through February will likely support the inflation hawks.
And so, enter the protesters in the streets of Libya, Egypt, Tunisia and across the Middle East and North Africa.
Whatever the outcome locally, the domino effect of public dissent and regime collapse seems to have finally spooked the oil market into significant price spikes. Brent crude is now up more than 10 percent from the beginnings of the Egyptian protests in late January to its highest since September 2008.
U.S. economist Nouriel Roubini, famed for his gloomy prognosis for the world economy prior to the 2007 credit crisis, reckons stagflation is a real threat from the Middle East unrest and noted that oil price spikes related to Middle East conflicts preceded three of the last five world recessions.
The risk of a growth hit together with interest rate rises would be toxic for junk bonds.
High-yield bonds have been trading like high-dividend equities since the height of the credit crisis and particularly again since the Fed mooted an additional bout of money-printing last August -- with high positive correlations between the two.
But junk debt is far more exposed to interest rate, or duration, risk in the event that both markets roll over for fear of early central bank policy tightening.
In an environment of rising official interest rates, it's more likely junk will return to trading more in line with benchmark government debt and the broader fixed-income universe.
But it's just as likely with that all three asset classes are forced lower in tandem until the coast is clear.