JC asked me how far I thought interest rates would pull back during a recent internal meeting.
The question caught me off guard since I trade bonds, not interest rates. I know my bond trade targets off the top of my head, but not the corresponding rate levels.
As soon as the call ended, I applied Fibonacci analysis to the 30- and 10-year yields…
The 3.50 level marks a logical area for the 30-year yield to stop falling.
That level coincides with a shelf of former lows and a critical retracement level covering the rally off the 2020 low.
The similar level for the 10-year yield stands at 3.25:
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:
Credit spreads have tightened a good deal since October.
I can't help but think this is just more classic bull market behavior.
As the major US equity indices have been rallying into year end, we've seen confirmation out of a number of credit ratios we track to gauge risk appetite within fixed income markets. Specifically, the the iShares High Yield Corporate Bond ETF $HYG is trading at 52-week highs relative to the iShares 3-7yr Treasury Bond ETF $IEI.
This ratio ultimately gives us an inverted chart of credit spreads. Check it out:
Notice how both the S&P 500 and the HYG/IEI ratio are pressing back through their summer highs.
It's hard to have a bull market in equities if the bond market is positioning defensively. Think about it; the players in the market with the deepest pockets require an incredible amount of liquidity.
Powell supposedly stated the obvious or blurted out what was on everyone’s mind. I don’t know. I haven’t watched the video or reviewed yesterday’s treasury auction.
And I won’t.
I’m more interested in the “what,” not the “why,” as the former has proven far more valuable for navigating markets.
The market barely reacted Wednesday afternoon following Powell’s remarks, cooking up a big, fat nothing burger for investors.
Market participants took the decision to leave rates untouched in stride. After all, the pause in the hiking cycle was the expected outcome. Since investors already pegged the Fed, the valuable information hung on Powell’s words or forward guidance.
Yet judging by today’s performance, it appears the market just needed a little time to marinate.
Yesterday’s failed reaction has given way to a delayed response as long-duration bonds scream higher.
But before we get ahead of ourselves and rush out to buy the bond market bottom, let’s check the charts…
Check out the 2s10s spread challenging zero from below:
An inverted yield curve (widely measured by the 2s10s and 3mo.-10yr. spreads) has cast a pall over capital markets, promising an economic recession for over a year. Yet the US economy remains strong.
Investors navigate a market of stocks, not a “stock market.”
Equity indexes slide, and US treasuries collapse against a rapid rise in interest rates. Unfortunately for the bulls, the charts show no signs of an imminent change in these underlying trends.
That’s the environment, and there’s no use fighting it.
Have no fear: We can still lean into market areas that enjoy a rising rate environment, mainly energy.
Here’s the US 30-year yield breaking to its highest level since the summer of ‘07:
US T-bonds are sliding to fresh decade lows. The S&P 500 completed a three-month top last week. And the Nasdaq 100 is on the verge of doing the same.
Those summer highs are receding into the collective memory bank, replaced by new lows and growing unease. Sellers are out in full force.
But instead of allowing the near-term selling pressure and overall choppy conditions to throw us off balance, let’s focus on the one underlying trend tying this market together…
Bonds across the curve are skidding to fresh contract lows as interest rates have a one-track mind…
Higher!
Check out the US 10-year yield posting fresh sixteen-year highs:
Not to be outdone, the 2-year yield just registered its highest level in seventeen years.
Interest rates across the curve are breaking to decade-plus highs in what has become a foot race.
It’s clear that the rising rate environment remains alive and well. An inverted yield curve keeps score, reminding us that shorter-duration yields are winning.
But I honestly don’t care what area of the curve is leading.