Hey There Income Hunter,

The Fed desperately needs help getting inflation down but yesterday’s headline (all items) and core (all items minus food & energy) CPI numbers were both higher than expected.

Elevated levels of inflation will continue to destroy consumer demand and tighten financial market conditions …

And we are starting to see the type of reaction you would expect when an economy and the financial markets are stressed.

Today, we’ll look at indicators that are getting close to warning of 2008 crisis conditions and what trades to keep an eye on. 

Credit Spread Warning Sign

At this point in a bear market in stocks, a breakout in corporate bond credit spreads is critical to watch out for … 

Well, this week, they broke out to wider levels. 

A widening of corporate credit spreads is when interest rates on corporate bonds rise relative to risk-free interest rates. This risk measure signals that we could begin to see high indebted issuers default on interest payments. 

Notice the recent breakout in the high yield-spread this week in the chart below …

Speculation

You can actually speculate on this risk measure by trading the iShares High Yield Corporate Bond ETF (HYG).

HYG is a great forward looking indicator for the equity indexes. Checkout the HYG chart with the Invesco QQQ Trust ETF (QQQ) overlay.

Notice how HYG topped out and rolled a month before the QQQ followed … This type of divergence between a stock and a bond issued by the same company gives you a huge hand in getting in on a low risk/high reward trade early. 

I have had HYG bear strategies on for most of this year and I think HYG may be getting ready for a more aggressive sell off in the months ahead. 

Once HYG gets going to the downside during a bursting of asset price bubbles it can go a long way. It usually begins when the Fed begins pulling back from easing financial market conditions.

Next, the trade picks up speed when the Fed announces a shift in policy to tightening …

I think we are heading to the third phase when the Fed overdoes the tightening and the asset bubbles pop causing a systemic failure. This is when companies default on payments causing bankruptcies and the labor market layoffs begin.

This cycle the risk is elevated due to the massive total debt in the US so I would expect HYG to make a new low to the mid-sixties before the Fed is able to reverse course and pivots back to printing money.

A bearish strategy on HYG can protect your portfolio and make you money in the difficult environment we are in. I have trades on to the June expiry which will take you through another Fed tightening meeting on June 17.

Over the next month, economic data will reveal the damage inflation and the Fed tightening is causing and that will pressure HYG lower.

Bring It Home

The market is waking up to the fact that the Fed is once again over promising on its ability to execute successful monetary policy …

Powell waited way too long to start tightening and now he is tightening into a recession. The team at the Fed are a bunch of clueless academics who do not understand market and financial stability risk. 

All they can do is react to backward looking data, which will once again have them go too far with the tightening and cause them to break something in the system.

The Fed has only two choices … one is to accept a higher level of inflation (in the mid-single digits) and slower growth (stagflation) …  the other is to blow up the financial system by letting the everything asset bubble burst and take a decade or more to bounce back. 

Bearish trades in HYG and bullish trades in real assets (commodities) i.e., producers will be the best performers as we head towards the inevitable Powell pivot back to printing money, which is what the Fed does best. 

Stay tuned and as always …

Live and Trade With Passion My Friend,

Griff