From the desk of Steven Strazza @Sstrazza and Ian Culley @Ianculley
We could sit back and speculate on what measures the Federal Reserve is likely to take to curb inflation. But it wouldn't change the fact that inflation is already here.
We’d rather focus on what market participants are doing now to position their portfolios for these inflationary pressures.
Since last year, inflation has gripped markets, and we don’t foresee it going away anytime soon. We think the best course of action is to get used to this environment and focus on assets that tend to perform well during periods of inflation.
One of our favorite ways to measure inflation expectations is by analyzing Treasury Inflation-Protected Securities (TIPS) versus Treasuries.
Relative strength from TIPS implies that investors are positioning themselves for a general increase in the prices of goods and services. That’s exactly what we’re seeing today.
Let’s take a look and discuss what we want to do about it.
Here’s an overlay chart of the $TIP/$IEF ratio and the US five-year breakeven inflation rate:
US Treasuries are off to their worst start in more than a decade as rates rise across the curve.
The US Aggregate Bond ETF $AGG is down more than 4% year to date. Treasuries can’t manage to catch a bid. And High-Yield Bonds $HYG have fallen off a cliff.
But this could all change quickly. Especially if stocks continue to sell off.
Money has to go somewhere as it flows out of equities. And with many bonds testing critical levels, it would make sense to see prices mean revert, at least in the near term.
Let’s take a trip around the bond market and discuss some of the key levels on our radar.
First up is the long duration Treasury Bond ETF $TLT:
After dropping 5.4% in the last three months, TLT has paused at a logical area of former support around 135. This the same level price rebounded from late 2019 and early 2021.
From the desk of Steven Strazza @Sstrazza and Ian Culley @IanCulley
Not all stressors are debilitating.
In some cases, stress can push us to perform at our highest level. But, of course, there are instances when opposing forces become overwhelming, making it near impossible to reach our goals.
We’ve all been there.
And the markets are no different.
While we keep tabs on our heart rate or blood pressure to gauge our stress levels, we focus on credit spreads to measure stress in the market.
Given that rates continue to rise worldwide, it’s an appropriate time to evaluate these spreads and the potential obstacles that may lay ahead for risk assets.
We recently broke down credit spreads in anticipation of them widening and outlined some charts that are driving this trend.
Read our January 27 post for more information about the ins and outs of credit spreads and how we analyze them.
Since these spreads provide valuable information on the health of the overall market, we’re going to check back in and discuss another chart that is on our radar.
From the desk of Steven Strazza @Sstrazza and Ian Culley @IanCulley
The middle of the curve is catching higher as the US 10-year Treasury yield pushes toward its next milestone at 2.00%.
Now that we’re starting to see some follow-through to the upside, it raises the question…
Are these new highs in the 10-year sustainable?
With inflation expectations just off their highs, short-term rates surging in the US, and yields ripping higher across the globe, we think the answer is a resounding yes!
A few weeks ago, we discussed how global yields -- particularly those in developed Europe -- were confirming the new highs for US yields.
Since then, we've only seen this trend accelerate. With central banks turning increasingly hawkish, rates continue to break out to new highs around the world.
Today, we're going to dive further into this theme by taking a look at a handful of benchmark rates outside the US.
From the desk of Steven Strazza @Sstrazza and Ian Culley @IanCulley
The path of least resistance is higher for yields, as the market continues to punish investors for buying bonds.
As long as that’s the case, we want to look for short opportunities when approaching the bond market.
Since the shorter end of the curve has ripped higher, the moves in these contracts and ETFs are extended. They simply don't offer favorable risk/reward trade setups at current levels.
We’re better off looking for ways to play rising yields further out on the curve in this environment.
We’re going to discuss how to do just that by covering a few charts that are setting up on the short side.
First up is the 30-year Treasury bond futures:
T-bonds are carving out a multi-year head-and-shoulders top above their pivot lows from last March.
From the desk of Steven Strazza @Sstrazza and Ian Culley @IanCulley
The Federal Reserve is doing its best to prepare the market for what is expected to be a year of rate hikes. But investors aren’t exactly enthusiastic about this outlook, as stocks came under further pressure following Wednesday’s Federal Open Market Committee announcement.
The bond market is also offering some valuable information again. And considering the recent volatility, it’s more important than ever to listen closely.
When we think about bonds, credit spreads are always top of mind, as they’re a great barometer of market health. When there's stress on risk assets, it shows up in credit spreads.
When analyzing credit spreads, all we’re doing is measuring the difference in yield between a Treasury (the safest bet) and a corporate bond (riskier asset) of the same maturity. If these spreads begin to widen, it’s usually problematic for equities.
From the desk of Steven Strazza @Sstrazza and Ian Culley @IanCulley
There have been some fireworks to kick off the new year. One of the biggest developments in 2022 has to be the US 10-year yield breaking to its highest level in two years.
The direction in which yields resolve from their 2021 consolidation will impact all the major asset classes, including bonds, stocks, and commodities. We’re already seeing procyclical assets catch an aggressive bid as the 10-year flirts with an upside resolution.
For now, the path of least resistance is higher. But we still need to see follow-through and confirmation before we can be comfortable that these new highs are here to stay.
When we look at the international bond market, it’s not just domestic Treasury yields that are on the rise. We’re actually seeing rates make new highs all across the developed world.
It seemed like the bond market was heading in the right direction – except for Treasury spreads. The 2s/10s spread was the missing piece of the puzzle, continuing to push toward new 52-week lows…
Until now!
Only a couple of trading sessions into the new year, the bond market is providing plenty of fireworks. Rates are jumping higher across the curve, and critical treasury spreads such as 2s/10s, are following higher:
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.
From the desk of Steven Strazza @Sstrazza and Ian Culley @IanCulley
Our focus has been on US Treasury yields in recent months – and for good reason.
The 30-year yield recently undercut its summer lows, and the 10-year yield briefly lost the critical 1.40 level. Both have since recovered. But these crucial rates remain stuck in the same messy ranges that have defined most of 2021.
Given the lack of decisive action in domestic yields, we think it's a good time to check in on the overseas bond markets in hopes of gleaning some insight into the potential direction of yields outside the US.
In today’s post, we’re going to switch things up and take a look at the 10-year yields from other major developed countries.
From the desk of Steven Strazza @Sstrazza and Ian Culley @IanCulley
It was only a month ago that we discussed the TIPS versus Treasuries ratio hitting its highest level since 2013 as investors prepared for rising inflation.
Fast-forward to today, and the inflationary backdrop looks very different.
Inflation breakeven and forward expectation rates have rolled over aggressively since the middle of November. This is illustrated by the TIP/IEF ratio, which recently undercut its May highs. Combine this action with the lack of follow-through on last week’s kick save from the 30-year yield, and the prospects of rates rising across the curve aren’t looking too hot.
But what does that mean for risk assets?
For starters, commodities will miss out on all the usual tailwinds that come with inflationary pressure. Let’s take a look at a chart that highlights that relationship.
From the desk of Steven Strazza @Sstrazza and Ian Culley @IanCulley
The recent risk-off action came to a head last week, with commodities, stocks, and interest rates all violating key support levels.
We saw a brief flight to safety, as long-term treasury bonds $TLT broke out to their highest level since early January.
Yes, money was flowing into bonds, which is not a good look for stocks and commodities.
Bottom line, there was a lot of damage done to the primary uptrend in a very short time. Market participants needed to come out and repair the damage ASAP.
In the handful of trading sessions since the selling stopped, bulls have managed to claw back much of the losses from last week.
Buyers needed to quickly step up to the plate. And that’s exactly what we’re seeing right now, as stocks and other risk assets are rebounding aggressively off the recent lows.
As for bonds, the breakout in TLT failed, and the 10-year and 30-year both snapped back above critical levels.
