The Bond Market Remains Stress-Free

From the Desk of Ian Culley @IanCulley

Credit spreads are the canaries in the financial market coal mine.

They’ll peep at the first sign markets face serious risks.

With stocks entering a corrective phase, it makes sense to seek information from the biggest exchange in the world.

The bond market.

Credit spreads remain tight despite increased selling across US equities.

That’s the opposite of what I’d expect during a severe selloff.

What does that tell us?

Check out the overlay chart of the Russell 2000 ETF $IWM with the high-yield credit spread ratio, $HYG/$IEI:

Spreads are contracting as the HYG/IEI ratio challenges new 52-week highs and the Russell 2000 retreats from a logical level of overhead supply.

A pause in the immediate trend for small-caps makes sense.

Corrective phases are a healthy part of any uptrend. Remember, price doesn’t move in a straight line.

Yes, it’s messy, but the bond market has yet to warn of a more severe pullback in stocks. 

The HYG/IEI ratio will experience a steep decline if broad selling pressure picks up steam for risk assets.

But that’s not the current state of the markets. 

Instead, bonds send a clear message of “all’s well” as spreads happily chirp away.

Countdown to FOMC

The market is pricing in a pause through Q1 of next year following last month's 25-basis-point hike.

Here are the target rate probabilities based on fed funds futures:

Click the table to enlarge the view.

This data is from the CME FedWatch Tool as of August 17, 2023.

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