Hey There Income Hunter,
The signposts we have been talking about for months are flashing RED.
We always talk about how critical it is to follow the bond markets, and this week provides a great example of that.
Stocks and bonds have been trending in the same direction since the beginning of the year …
Down in price.
Over the past month I’ve said we need to get ready for the Fed pivot back to quantitative easing.
Well, on Tuesday as the S&P 500 index (SPX) rolled over and traded down, the iShares Treasury Bond ETF (TLT) broke out to the upside …
Notice in the chart below how the old correlation of stocks down/bonds up is back:
This is about bond investors anticipating that the Fed will have to start supporting the bond market or risk a debt crisis.
Today, I’ll show additional signs from corporate bonds and bank spreads that reveal the possible timing of the Fed pivot back to QE.
Recession in Session
If you have not yet read my report from Thursday on why the Fed must pivot back to QE, it’s here.
The bottom line is we now know the US is in recession.
The Atlanta Fed’s GDPNow forecast is for a -1% GDP for Q2. Ater a GDP report of -1.6% in Q1, we now have met the popular definition of recession.
I called the recession early, and said it would come in Q2 because I know how the Fed works and the bond market is always ahead of the central bank.
You simply can’t wait until the Fed makes policy changes because then it is old news. Power Income is about getting out in front by observing the critical bond market signals.
So let’s look at a critical signal that is forecasting problems in the financial system …
Normally when economic growth slows, it can be fixed by the Fed just simply lowering interest rates to ignite more spending …
However, when the US total debt is up near $90 trillion, like it is today, and growth slows, we are at risk of defaults and rating downgrades of corporate bonds that can trigger a debt crisis.
The chart below shows the BBB credit spread to the risk-free rate. The reason this is so critical to watch is this …
When this spread rises, that signals that some companies may be having problems borrowing at the new higher rates and remaining profitable.
When rates rise just as costs are rising and sales are slowing, that can ignite a domino effect throughout the system as it did in 2008.
Today, I am going to show you how you can watch this just as you watch any single stock.
The Paired ETF Credit Spread
The chart below shows the Ratio of the iShares Investment Grade ETF (LQD) to the iShares 7-10 year Treasury Bond ETF (IEF).
TradingView is my charting platform and it allows you to create ratios. Here I just put in LQD/IEF and the ratio pops up.
Ratios, in general, provide great insight into finding trade ideas and understanding correlations that make sense in different trading environments.
The symbol you put first in the ratio is the one reflected by the trends of the ratio.
Notice how the swings in the ratio are moderate between the 2008 and 2020 recessions, but when recession hits it can explode to the downside …
The skill needed in these trades is optimization of strategies to utilize for the trade.
That is where Option Pit shines … finding the lowest risk/highest reward strategies makes a huge difference in how consistently successfully you can be.
Bring It Home
Jerome Powell is attempting to convince the market that the Fed must tighten to fight inflation regardless of the US being in recession.
That is a total political charade because obviously J-Pow and co. can’t be honest about how bad the situation really is or we would be back in the 2008 mess.
That is why you must look to the market internals for clues on the trades that provide the lowest risk and highest reward opportunities.
July really starts on Tuesday for the marketsCome ready and rested!
Happy 4th of July and as always …
Live and Trade With Passion My Friend,
Griff