FALLING ENERGY PRICES ARE AFFECTING BOND RELATIONSHIPS -- LONGER MATURITIES ARE RISING FASTER -- AND INFLATION PROTECTED BONDS ARE LAGGING BEHIND -- ENERGY RELATED HIGH YIELD BONDS ARE ALSO WEIGHING ON THAT SECTOR -- CRUDE OIL IS TESTING NOVEMBER LOW
LONGER MATURITY BONDS ARE RISING FASTER ... We can often get clues about market sentiment by comparing different parts of the fixed income universe. A lot has been written about the falling yield curve, which plots the difference between 10-Year and 2-Year Treasury yields. That usually signals expectations for lower inflation. Here's another variation on that theme. The green line in Chart 1 plots ratio of the 20+ Year T-Bond iShares (TLT) divided by the 7-10 Year iShares (IEF). The rising green line since March means that the longer maturity bond ETF is rising faster than the shorter duration ETF. Longer maturity Treasuries are more sensitive to inflation expectations, so they usually do better in a climate of falling inflation. Speaking of which, notice that the bond ratio started rising in March as the price of crude oil started falling.
(click to view a live version of this chart)
Chart 1
TIPS ARE UNDERPERFORMING ... Here's another variation on the same theme. The green line in Chart 2 plots a ratio of Treasury Inflation Protected Bond iShares (TIP) divided by the 7-10 Year Treasury iShares (IEF). The falling green line means that TIPS have been underperforming Treasuries throughout the first half of the year. TIPS are government bonds whose face value rises with inflation. When investors expect higher inflation, they prefer TIPS. Lower inflation expectations make TIPS less attractive. Notice here again a close correction between TIPS underperformance and falling gasoline prices.
(click to view a live version of this chart)
Chart 2
HIGH YIELD BONDS ARE LAGGING BEHIND... Here's one more. Chart 3 plots a ratio of the iBoxx High Yield Bond iShares (HYG) divided by Investment Grade Corporate Bond iShares (LQD). The ratio has been dropping since March (when crude oil started dropping). Crude has lost more than 20% of its value since then. That's not good for energy-related high yield (junk) bonds which are vulnerable to falling oil prices. For one thing, it makes it harder for them to borrow. That's because their yields are rising. An article in today's Wall Street Journal entitled "Energy Sector's Junk Debt Loses Appeal" points out that yields on energy junk bonds have risen to the highest level of the year (meaning their prices have been dropping). According to the WSJ, those energy companies account for 14% of the high yield market. That's weighing on the entire high yield group. Chart 4 shows the High Yield Corporate Bond iShares (HYG) having fallen to the lowest level in a month in heavy trading. It is, however, trying to find support at its 50-day average and no serious chart damage has been. But Chart 4 is worth keeping an eye on. That's because junk bonds usually trend in the same direction as the stock market. [The 60-day Correlation between the HYG and S&P 500 is 90%].
(click to view a live version of this chart)
Chart 3
(click to view a live version of this chart)
Chart 4
WTIC CRUDE TESTS MAJOR SUPPORT NEAR $42... This year's 20% drop in crude oil hasn't caused serious problems outside of energy stocks and, to a lesser extent, energy-related junk bonds. That muted reaction, however, may depend on what oil does from here. Chart 5 shows the price of Light Crude Oil ($WTIC) having fallen to the lowest level since last November near $42 (see circles). That's a very important test of support. In addition, its 50-day moving average has fallen below its 200-day line which is a negative sign. The only bright spot is that its 14-day RSI line is in oversold territory below 30. The burden of proof is on the oil market to prove that it can halt its decline and regain some lost ground. Crude oil is bouncing modestly today. A lot may be riding on that bounce continuing. That includes the direction of foreign currencies and stocks in countries that export the commodity.
