Over the past month, the equity market has diverged significantly from the credit markets. The stock market has been on a rocket ship to the moon, while the credit markets are sending a much different signal.
Let’s go over some charts to get a sense of what is happening in the bond market.
The front end of the curve is rising in yield, which is what you would expect with the Fed’s continual threats to raise rates. The 2 year treasury yield is once again pushing up towards the high of the recent range.
But even though the front end of the curve is selling off, the longer end is fairly well bid. The US 10 year treasury yield is still sitting down near the recent lows.
This is resulting in a flat yield curve.
This flattening of the yield curve is signalling the Fed’s tightening will slow down the economy more quickly than the Federal Reserve believes. The Fed’s tightening rhetoric is driving up short term yields, but the longer term yields are not rising correspondingly. The Fed is in essence getting out ahead of the curve, as opposed to following the market higher.
This is confirmed by the terrible action in credit spreads. Corporate bonds have been trading like garbage, and it is clear fixed income traders are no where near as optimistic about the economy as their equity coworkers.
For those who need to see what that credit widening looks like in terms of price, here is a chart of the JNK, Barclay’s high yield bond index ETF.
The damage is quite extensive. Not only that, the bounces have been extremely shallow.
Which brings me back to my main point about the conflicting signals the bond market is sending versus the equity market.
Even though the equity market has rallied hard over the past month, credit markets are not confirming this ‘risk on’ rise.
The corporate bond market is not the only correlated fixed income market that is sending a different message than equities. Generally break even inflation rates move in tandem with risk assets.
However, the recent rise in equities is eclipsing any sort of muted rise in breakeven inflation levels.
I don’t think equities can continue to rally with the;
the front end of the curve rising in yield
the yield curve staying flat
corporate bonds selling off
breakevens staying low
The buying in the stock market is panicky and relentless. But the fixed income markets are sending a different message. Over the years I have learned the hard way that when these two market differ, it’s best to listen to the bond traders.
Thanks for reading,