Hey There Income Hunters,
Another day, another first.
Junk bond yields have dropped below 4% … for the first time ever.
You can see below that the Bloomberg Barclays U.S. Corporate High Yield index dipped to 3.96% on Monday evening, its sixth straight session decline …
Even with my 40 years of experience in the bond market, it’s hard to rationalize this one …
If US Treasury Bond yields were also setting new lows, that would be one thing …
But they’re doing the opposite!
Check it out …
Treasury yields are moving higher, while lower rated bond yields are collapsing.
Makes you go hmmm …
Thinking Through It
Two things the Fed can’t control at the same time are:
-
Bankruptcies
-
Inflation
Here’s the logic …
Let’s say the Fed gets inflation to 3%, as I think they will, possibly this year.
Well, now the Fed has to raise interest rates to stabilize inflation or they risk losing control.
Higher interest rates can be detrimental to low-rated corporations that carry a large debt burden … Any increase in their cost to carry the debt, means they can quickly become insolvent.
Now, check out how bond buyers are accepting lower rates and increased risk …
This is a consequence of the Fed holding interest rates abnormally low and it means that investors end up taking on more risk than they should.
Weighing a Trade
When I saw the junk bond yields dip, I immediately thought about putting on a bearish trade on the iShares High Yield Corporate Bond ETF (Ticker: HYG) …
However, I didn’t see don’t see any technical indicators, meaning momentum or bearish patterns, that lead me to believe the trend is going to reverse…
I also don’t think we’re that close to the Fed having to raise rates. It won’t be an issue until inflation is above 2.5% … and that may not come until mid-year. So I’ll just watch for now.
I will, though, be on the lookout to see how it trades against the blue trend line above and look for a negative price/Relative Strength Index (RSI) divergence.
RSI is a very helpful technical momentum indicator and price/RSI divergences are often great signals that a trend reversal is coming. They occur in a downtrend when prices make new lows but the indicator doesn’t follow suit.
Bring it Home
Look back at the last chart and notice HYG’s sharp decline during the financial crisis of 2008 …
High-yield debt rates and their yield spreads compared to US Treasuries, known as credit spreads, are a very important indicator of liquidity (cash availability) in the markets …
When spreads widen, meaning high yield bond rates go higher relative to Treasury rates, it is a sign lower rated companies are being squeezed for cash. …
So, in conclusion, credit spreads being at their narrowest in history confirms the fact that there is massive liquidity being injected into the markets …
The inflation trade indicators are all green …
Have a great day and as always …
Live and Trade With Passion My Friends,
Griff