From the desk of Steve Strazza @Sstrazza and Ian Culley @Ianculley
With the exception of US large-caps, the market remains range-bound for most risk assets. At the same time, most defensive assets are failing to catch any meaningful bid.
Gold is still chopping around in the middle of its year-to-date range. Bonds continue to trend sideways or lower. The Japanese yen recently hit its lowest level since 2017.
And while the defensive sectors recently made multi-month highs versus the broader market, they’re still trading near 20-year lows on a relative basis.
These are the kinds of assets we expect to catch a bid in an environment where investors are fleeing for safety and positioning defensively. But we’re just not seeing that.
At the same time, we haven’t seen many definitive signals supporting a more risk-on tone… until now!
While our risk-appetite ratios remain a mixed bag and most are simply range-bound, we just got a meaningful upside resolution in the High Yield versus Treasuries ratio.
The ratio of high-yield corporate bonds versus US Treasuries has been consolidating beneath a critical level of former support turned resistance for the past nine months. After challenging this level several times, the ratio appears to be resolving higher — in favor of High-Yield Corporate Bonds $HYG:
This is a big development, as the bond market is sending a clear message that investors are reaching for more risk.
High-yield bonds are often referred to as “junk” because they carry a higher degree of risk than their fixed-income alternatives. To see market participants taking on increased risk in search of higher returns is constructive for risk assets in general. It’s something we see during uptrends.
Maybe the animal spirits are coming back to life after taking most of 2021 off?
We need to see similar action from other risk ratios to confirm this, but seeing high-yield outperform again is a good start. Another important relationship pointing in the bulls’ direction right now is the stocks versus bonds ratio, as SPY/TLT just reclaimed its year-to-date highs.
The bottom line is that these ratios making new highs is supportive of new highs for risk assets, as it suggests that investors are starting to position more offensively.
Combine this with the S&P 500 recently printing new all-time highs, and the bond market could be providing an early indication that risk-seeking behavior is re-entering the market. If this is the case, we’d expect a new leg higher for stocks and commodities to be underway… and soon.
The AUD/JPY catching higher, the US Dollar Index $DXY rolling over, and more and more cyclical assets resolving higher from their ranges would further support this development.
Of course, we also want to see upside follow-through in HYG/IEI and other risk-appetite ratios such as SPY/TLT.
In recent weeks, the bulls have gradually put points back on the board. While there’s plenty more work to be done, we want to give them the benefit of the doubt for now.
Countdown to FOMC
Following the Federal Open Market Committee meeting earlier in the month, the market is now pricing in the first rate hike in May 2022.
Here are some of the probabilities for the May meeting based on fed funds futures:
- 0-25 bps hike: 25.7% probability
- 25-50 bps hike: 51.1% probability
- 50-75 bps hike: 22.2% probability
- 75-100 bps hike: 1.0% probability
Thanks for reading. As always, let us know what you think.
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