And don’t worry: Plenty of banter surrounding the yield curve will take center stage during all this recession talk.
Somehow, an inverted yield curve has become synonymous with recession even though the historical record supporting this narrative leaves room for plenty of interpretation.
The purpose of this post is not to present an argument on whether we’re already in a recession or if one is imminent. We’ll leave that up to the talking heads and economists.
Instead, we'll simply share where the yield curve is today and assess the likelihood of potential inversion.
Let’s take a look…
Here’s a triple-pane chart of the US 30-year, 10-year, and 5-year yields:
From the desk of Steven Strazza @Sstrazza and Ian Culley @Ianculley
The Japanese yen continues to be front and center, as the safe-haven currency can't seem to find its footing.
In a market where risk assets are struggling to catch any sort of sustained bid, finding investment opportunities in yen has been a great strategy. It continues to work.
Aside from providing a stellar trading opportunity, the current intermarket relationship between this forex cross and the bond market may reveal the near-term direction of the US 10-year yield.
Let’s take a look.
Here’s an overlay chart of the USD/JPY pair and the US 10-year yield with a 26-day correlation study in the lower pane:
From the desk of Steven Strazza @Sstrazza and Ian Culley @Ianculley
Back in January, the big story was the yield on the 10-year US Treasury note printing new multi-year highs.
At the time, other benchmark yields worldwide were also resolving higher, completing large bases.
This was confirming evidence that added to our conviction US yields were headed higher and that we were in the early stages of a rising rate environment.
The confirmation from global yields proved valuable information.
Almost six months later, the US benchmark is just below 3.00%. As it pauses below a critical level, we again turn to overseas rates to get a read on the potential near-term direction of the 10-year yield.
And just like earlier in the year, they’re pointing higher.
From the desk of Steven Strazza @Sstrazza and Ian Culley @Ianculley
When it comes to the bond market, credit spreads are always top of mind. They provide critical information regarding the liquidity and stress of the largest markets in the world.
While most of us aren’t full-time bond traders, in many cases we turn to these assets to offset the risk associated with the equity side of our portfolios. That’s fine.
Earlier in the month, we noted that these crucial spreads were widening to their highest level since late 2020 as the high-yield bond versus Treasury ratio $HYG/$IEI hit new 52-week lows.
It’s no coincidence that the major stock market averages fell to their lowest level in over a year as this was happening.
This is why we pay close attention to credit spreads. They give us information about the health of other risk assets.
That’s because those former highs marked significant peaks for both the stock market and certain procyclical commodities and currencies during the last cycle.
As far as the bond market is concerned, 2018 was also when yields peaked. Benchmark rates in the US are testing these old highs.
As such, it’s not the 2018 highs but the 2018 lows that we’re paying attention to when analyzing the prices of Treasuries.
A handful of bonds and bond funds are trying to find a bottom at these key former lows right now.
From the desk of Steven Strazza @Sstrazza and Ian Culley @Ianculley
Credit spreads are widening to their highest levels since late 2020.
If it feels like we just mentioned spreads and the falling HYG/IEI ratio, it’s because we did – and for good reason! They provide valuable insight into the overall health of the market.
We’ve been closely following the HYG/IEI ratio for months as it repeatedly tests the lower bounds of its range. It broke down to fresh lows in March, only to bounce higher with many risk assets.
Two months later, this crucial risk ratio is printing fresh 52-week lows again. The main difference is that the overall market environment has drastically changed since the last time we were at these levels.
Defensive areas we would expect to underperform in the current environment such as utilities and REITs are actually outperforming.
And the names we would expect to do well – specifically banks – can’t seem to catch a bid on either absolute or relative terms.
This is concerning from a broader intermarket perspective. But it’s not the complete story.
While our stock market ratios are not supportive of higher rates, when we look within the bond market, we’re seeing the opposite.
Not only is there a synchronized global rally in interest rates, but the intermarket evidence from our bond market ratios supports this action and indicates a healthy degree of risk appetite.
Today we're going to highlight one of those bond market ratios – high-yield vs. investment-grade debt.
From the desk of Steven Strazza @Sstrazza and Ian Culley @Ianculley
Treasury Bonds have collapsed in recent months as interest rates have rallied to their highest levels in years.
And it’s not just treasuries, the trend is lower for corporate bonds as well.
While fixed income markets have experienced steady selling pressure since 2021, downside volatility has accelerated in recent months. Following the worst Q1 returns in decades, bonds have continued to plunge to kick off the 2nd quarter.
The best way for us to take advantage of this is to keep finding clean setups to short.
Today, we will outline a couple of shorts in high-yield debt and discuss what a sustained downtrend for these bonds could mean for the broader market.
First up is the High-Yield Corporate Bond ETF $HYG:
From the desk of Steven Strazza @Sstrazza and Ian Culley @Ianculley
Benchmark yields have moved in a vertical line higher since the beginning of March. This isn't just the case in the US; we're seeing similar action all across the globe.
But as rates rally higher and higher, more and more classic intermarket relationships are failing to confirm the move.
Yes, commodities and commodity-related stocks remain resilient, and bonds are an absolute dumpster fire.
Most other assets we would expect to do well in a rising rate environment simply aren’t. This is especially true for the banks!
Meanwhile, those groups that we'd expect to underperform in this kind of environment, such as utilities and other defensive stocks, are actually outperforming.
All of this speaks to risk-aversion, not risk-seeking behavior.
From the desk of Steven Strazza @Sstrazza and Ian Culley @Ianculley
It finally happened…
The yield curve inverted for a brief moment as the 2-year yield rose above the 10-year earlier this week.
But whether or not it inverted yet is beside the point. It’s been flattening for a long time, and that’s the direction we’re headed in. It's only a matter of time.
While media outlets and fearmongers will spin this development as an urgent warning of an impending bear market, here's what you need to know: Throughout history, equities have done well during and after inversions.
This commonly observed leading indicator has a tendency to precede major market tops by years, not months. In other words, there's still time. The average lead time is about 18 months after prior inversions.
More importantly, when it comes to forecasting bear markets and recessions, many experts will argue that it is actually not the 2-year we should be focused on, but the 3-month yield.
From the desk of Steven Strazza @Sstrazza and Ian Culley @Ianculley
It's beginning to feel more and more like a risk-on environment out there.
Commodities are ripping higher. Stocks are digging in at critical levels. And defensive assets such as Treasury bonds and the Japanese yen are in freefall.
Despite the market volatility this year, investors continue to be rewarded for buying stocks over bonds. This has been the case for two years now, and there's no evidence it will change anytime soon.
When we look to our risk indicators and risk appetite ratios, the majority are still stuck in a range. With the stocks versus bonds ratio resolving to fresh highs, we're thinking the rest may soon follow.
But first and foremost, the price action from this classic intermarket relationship suggests that stocks are still the place to be.
Let’s take a look.
Here’s a chart of the S&P 500 $SPY versus US T-Bond ETF $TLT:
From the desk of Steven Strazza @Sstrazza and Ian Culley @Ianculley
Benchmark rates around the world have been rolling over as uncertainty sweeps across markets.
Despite the growing pessimism among investors, global yields are digging in at critical levels and bouncing higher in recent sessions.
We discussed how international yields – particularly those in developed Europe – confirmed the new highs in US rates earlier in the year.
Today, we’re going to check in on some of those same yields and see if this is still a piece of confirming evidence for rates here in the US.
With the US 10-year hovering around its breakout level at last year’s highs we’re looking for any clues we can get for whether or not these new highs are here to stay.
If the new highs in global yields are holding, that would go a long way in supporting the upside resolution in the US 10-Year.
On the other hand, if we start to see more and more yields around the world fail and roll over, the US will likely follow.
