Bonds Sweeten a Potential Santa Claus Rally

From the Desk of Ian Culley @IanCulley

The bond market is turning the page. 

Our long US Treasury trades are finally working. And investors are reaching for high-yield debt.

On the surface, it’s a positive shift for the hardest-hit markets in 2022. 

But it also sends a clear message to stock market investors…

Buy!

Credit spreads are contracting as the iShares High Yield Corporate Bond ETF $HYG trades at fresh 52-week highs relative to the iShares 3-7yr Treasury Bond ETF $IEI:

It’s classic bull market behavior.

But that’s not all…

The newest junk bonds to hit the street are catching higher on an absolute basis. 

Check out the Fallen Angel High Yield Bond ETF $ANGL:

Stocks have a strong tendency for positive gains when investors are willing to take increased risks in the bond market.

Unsurprisingly, ANGL and the S&P 500 $SPX are almost a mirror image. Both reflect fresh highs.   

As if it couldn’t get any better for equity bulls, bond market volatility is carving out a classic topping formation:

The MOVE chart looks like a sell to me – at least if and when it undercuts the shelf of former lows (highlighted with green arrows.)

But we don’t trade this index. It’s for informational purposes only and not to be used as an investment vehicle.

We’re not shorting bond market volatility as is contracts. Instead, we’re buying stocks.

The overlay chart of the MOVE and S&P 500 indexes proves my point:

Stocks prefer a quiet bond market. 

That’s what’s been on the menu since October. Whether it becomes a staple in the coming months will dictate the direction of the broader equity markets (lower MOVE Index equals higher stock prices, and vice versa). 

Credit spreads are tightening. High-yield bonds are attracting investors. And bond market volatility is shrinking.

Oh yeah, and the US dollar is rolling over.

It looks like the stock market has all the ingredients for a Santa Claus rally. 

Can it bake?

Stay tuned.

Countdown to FOMC

The market is pricing in a pause in the hiking cycle until March 2024, as investors anticipate three potential cuts next year.

Here are the target rate probabilities based on fed funds futures:

Click the table to enlarge the view.

This data is from the CME FedWatch Tool as of December 13, 2023.

Thanks for reading.

Let us know what you think.

And as always, be sure to download this week’s Bond Report!