March 27, 2018 | by Matthew Pasts, CMT, CEO, BTS Asset Management, Inc.

High Yield Bonds Trading More in Line With S&P 500 Market Action

The high yield bond market has been trading in close correlation with the price action of the S&P 500. Both are trading near the mid-point between recent peaks and troughs. From here, we could see both break out to new highs or drop back and test new lows. Technical analysis of historical price patterns supports both possibilities.

In our opinion, a decline appears the more likely outcome given the downward slant of the recent price pattern. The high yield asset class tends to move in sustained trends, and intermediate-term moving averages currently have a negative slope: the 30-day simple moving average is below the 40-day simple moving average on many high yield indexes.

That said, stabilization and trend reversal is possible. If stocks move toward their January 26, 2018 highs, that market action may support the high yield bond market.

New cycle of higher yields

More generally, high yield bonds are challenged by what appears to be the beginning of a cycle of higher yields, both from higher Treasury yields (an overall negative for both stocks and high yield bond prices) and, eventually, wider credit spreads.

Inflationary pressures may push interest rates higher—and the risk of entrenched inflation may not be fully priced into the market. With the 10-year Treasury yield breaking 2.6% and challenging the pivotal 3% level, any continuation of higher inflation readings could move the 10-year yield to 3% and higher this year. This would certainly pressure the high yield market as yield spreads are historically low.

In short, BTS indicators are not yet positive despite a few signs of price stability off the early February lows.

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