Financial markets are in reflective mood as we start a new week, there seems to be a willingness to recalibrate the Trump trade, however no one seems ready to press the sell button. Likewise, there is anticipation that US Treasury yields will rise especially now that the Fed is hiking interest rates and talking about shrinking its balance sheet, however the 10-year yield is still below 2.4%. Investor sentiment is also starting to nose-dive, however, traders aren’t willing to put their money where their mouths are.
The two charts below highlight the dichotomy that is at play in the markets right now. On the one hand there is a smell of caution in the air, but on the other, capital is not yet moving away from risky assets. The first chart below is the Credit Suisse (SIX:CSGN) fear barometer, which measures investor sentiment for a 3-month horizon. This has reached its highest level since November 2016, as US–Russian fears boil over, French election and Brexit risks bite and people worry about the Fed tightening monetary policy. These fears may keep investors up at night with worry, but it is not impacting where they put their money, as chart 2 shows.
The second chart shows the Barclays (LON:BARC) US Corporate high yield debt – 10-year US Treasury spread, which remains close to its lowest level since 2014, and is looking remarkably stable. This spread, which measures the cost of capital for higher risk US corporates vs. the United States Government, usually spikes when risk aversion rises. The fact that it has barely moved even though risk indices have picked up, can tell us a few things about where asset prices may go in the coming weeks.
Credit Suisse Risk Barometer
Barclays high yield corporate debt – US 10-year Treasury yields
What this dichotomy tells us:
· A sell off in risky assets will happen, just not yet. The fears in the markets are real and investors recognise them, however they may think of these risks as “sleeping bears” who are not ready to strike yet.
· This helps to explain why volatility has remained contained even in the face of what looks like serious market risk.
· It may also suggest that investor risk sentiment can be choppy, and shouldn’t be used to time market moves.
· When the Barclays high yield corporate credit spread vs. US Treasury yield starts to rise then investors should get worried.
· The US corporate high yield spread should be used to time market moves rather than risk sentiment indicators. The US corporate high yield spread has a significant negative weekly correlation with the S&P 500 at -60% for the last two years. If this correlation is to hold, then we would expect the S&P 500 to continue to rally if the US corporate high yield spread continues to narrow, and vice versa.
· If this dichotomy between investor sentiment and asset prices persists then we could be in for a range-bound summer for the financial markets.
Disclaimer: The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase or sale of any currency or CFD contract. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. Any references to historical price movements or levels is informational based on our analysis and we do not represent or warrant that any such movements or levels are likely to reoccur in the future. While the information contained herein was obtained from sources believed to be reliable, the author does not guarantee its accuracy or completeness, nor does the author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.