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What Junk Bonds Are Telling Us About Interest Rates

Last week, we discussed how rapidly rising interest rates have started to put huge pressure on home price growth and retail sales.

Today, I want to continue with that theme by looking at another asset class directly affected by changing interest rates… high-yield (junk) bonds.

When interest rates are falling, money flows into riskier assets like junk bonds as investors seek out higher yields…

But when rates start to rise, that money flows back the other way because investors can generate sufficient returns by investing in assets like government bonds.

You can see how that money flow played out last year in the chart of iShares iBoxx $ High Yield Corporate Bond ETF (HYG) below.

Rallying Off Short-Term Support

The chart of HYG below shows its steady decline from the start of 2022.

Once the year kicked off, HYG started heading down…

The 10-day moving average (MA – red line) crossed below the 50-day MA (blue line). Both then started tracking down. Take a look…

iShares iBoxx $ High Yield Corporate Bond ETF (HYG)

Source: e-Signal

Also, notice the action of our momentum indicator, the Relative Strength Index (RSI)…

It broke down through support (green line) at around the same time the 10-day MA crossed below the 50-day MA. Then it bearishly tracked in the lower half of its range (apart from a brief spike in May at ‘A’) throughout HYG’s down move.

We last looked at HYG in August last year (red arrow). At that time, HYG had reversed lower from that spike at ‘A’ and found short-term support (left orange line) from June through July…

That coincided with the RSI forming a ‘V’ out of oversold territory (lower grey dashed line) and steadily tracking higher (left red line).

Then, as buying momentum rose, the RSI broke back into the upper half of its range…

And the 10-day MA also bullishly broke back above the 50-day MA. That was a sign of a promising rally.

However, that buying momentum (RSI) petered out and rolled over, forming a lower high at ‘B.’

Take another look…

iShares iBoxx $ High Yield Corporate Bond ETF (HYG)

Source: e-Signal

From there, HYG then traded lower until bottoming out from September through October with a repeat of the previous pattern from June through July…

The RSI formed another ‘V’ from oversold territory and tracked higher (right red line). That enabled HYG to form another short-term support level (right orange line).

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Since then, HYG has been slowly grinding higher.

So what am I expecting from here?

Maintaining Momentum

For HYG’s rally to maintain momentum, we’ll want to see the RSI remain in the upper half of its band…

When the RSI briefly dipped below support late last year, HYG also fell… before bullishly forming a higher low at ‘C.’

The other thing I’m watching is our MAs…

Apart from that brief dip down to ‘C,’ the 10-day MA has bullishly remained above the 50-day MA since November. And both MAs are now also trending higher.

As long as both MAs continue to track higher and the RSI can remain in its upper band, the rally will continue.

Beyond that, the next test for HYG will be to take out its previous peak at ‘B.’

Regards,

Larry Benedict
Editor, Trading With Larry Benedict

Reader Mailbag

In today’s mailbag, a few One Ticker Trader members thank Larry for his recent guidance on a trade recommendation…

Thanks for the update on AAPL. I’m onboard and was thinking the same as your approach, but I really appreciate your perspective while hanging on. Hoping for the turnaround. – William T.

What a great and timely update! This is my first put position, and I was having a hard time seeing where our profit was going to be. Easy to see a call profit as you buy at a point, and it goes up a few cents and we grab a decent profit. But betting against Apple and paying the premium?

Even if you had bought the other way, you’re hedging the stock won’t move down and it goes straight up? No one felt good about this position either way.

Now, as AAPL moves to that level during this huge selloff going on – with earnings reports looming over their shoulder – I can at least see a glimpse of your genius, albeit three weeks behind… but I’m learning! Awesome Larry, thanks. – Rick G.

Thanks for sending in your thoughts! If you have any questions or comments, then you can always send them to feedback@opportunistictrader.com.