Beware: the bond market is signalling troubles ahead Beware: the bond market is signalling troubles ahead Beware: the bond market is signalling troubles ahead

Beware: the bond market is signalling troubles ahead

Bonds
Althea Spinozzi

Head of Fixed Income Strategy

Summary:  It's time to turn cautious as the bond market is signalling a swift rise in interest rates amid strong inflationary pressures and more aggressive monetary policies. So far, risky assets have suffered due to a rise in interest rates. However, things can quickly turn for the wort as corporate spreads begin to widen as financial conditions tighten. As the Federal Reserve prepares to hike interest rates, we expect breakeven rates to drop and real yields to accelerate their rise, posing a threat to risky assets. Nominal yields will continue to rise, too, as they already point to much higher levels we have seen this year. Given the market volatility, we don't exclude seeing 10-year TIPS yields rising to 0.5% and 10-year nominal yields to 2% by the end of the year.


Investors should start to worry about their investments as there are signs of US Treasury yields moving higher, dragging with them lower-rated credits.

HYG, the iShares iBoxx High Yield Corporate Bond ETF, has broken a key support level at 86.5. Moving averages are all dropping in a sign that the ETF could further fall. Once the weak support line at 85.7 is broken, the ETF will likely continue its fall to 84.8. 

Source: Bloomberg and Saxo Group.
Don't jump to conclusions. The current drop in HYG and JNK (the SPDR Bloomberg High Yield Bond ETF) has been driven entirely by the recent rise in yields. Indeed, while the average yield to worst of US Corporate junk bonds has risen to 4.6%, the highest level since December 2020, their option-adjusted spread (OAS) remains around 300bps. That's in line with the level seen before the 2008 global financial crisis. It means that the JNK and HYG are falling due to a rise in interest rates and not because there are signs of distress in the weaker corporate bonds space. While with individual bonds, one can mitigate the risk of rising interest rates by holding the bond until maturity, it's impossible to do so with ETFs because there is no maturity date for these products. It highlights that amid an environment of high inflation and rising interest rates, it's essential to search for yields removing as much duration as possible. The junk bond market can provide for that, but it's critical to be prepared to hold those bonds until maturity.
Source: Bloomberg and Saxo Group.

The problem is that the higher US Treasury yields soar, the more pressure will be applied on weaker bonds, ultimately causing credit spreads to widen. At that point, it will be too late for risky assets as volatility will become endemic in both the bond and stock market.

One way to know when we might face a broad selloff is to monitor real yields. The faster they rise, the quicker financing conditions are tightening for the corporate space. Real yields remain well below zero. However, as the Federal Reserve prepares to tighten the economy, we can expect breakeven rates to fall and nominal yields to rise, accelerating the rise in real yields. That could provoke a deep selloff, not only within the junk bond space but also in stocks with high duration, such as tech stocks. That's is what happened amid the Taper Tantrum in 2013.

Source: Bloomberg and Saxo Group.

Therefore, it is vital to monitor the movements of both real and nominal yields. Below, we are going to highlight some critical levels.

Real yields

Ten-year TIPS have traded rangebound since August. However, if they break above their descending trendline, they will likely rise to test resistance at -0.70%. If interest rate hikes accelerate by the end of the year, we can expect real yields to rise to -0.50%. Partly, valuations will continue to be supported by negative real yields. Still, repricing will be inevitable due to the fast rise of real yields.

Source: Bloomberg and Saxo Group.

Nominal yields

Ten-year US Treasuries are trading in an uptrend. Yet, we expect them to remain in check until the debt ceiling crisis has been resolved, as they will serve as a safe haven amid volatility in money markets. At that point, they are likely to break above 1.75% and continue to rise to 2% amid inflationary pressures and more aggressive monetary policies.

Source: Bloomberg and Saxo Group.

Five-year yields are also trading in an uptrend towards 1.50%.

Source: Bloomberg and Saxo Group.

Two-year yields are likely to accelerate their rise as the market prices earlier interest rate hikes. Yields broke resistance at 0.55%, and they are now in a fast area which could take them quickly to 1%.

Source: Bloomberg and Saxo Group.

Disclaimer

The Saxo Group entities each provide execution-only service, and access to analysis permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Inspiration Disclaimer and (v) Notices applying to Trade Inspiration, Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular, no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
Full disclaimer (https://www.home.saxo/en-sg/legal/disclaimer/saxo-disclaimer)

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments. Saxo Markets does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo Markets or its affiliates.

Saxo Markets
88 Market Street
CapitaSpring #31-01
Singapore 048948

Contact Saxo

Select region

Singapore
Singapore

Saxo Capital Markets Pte Ltd ('Saxo Markets') is a company authorised and regulated by the Monetary Authority of Singapore (MAS) [Co. Reg. No.: 200601141M ] and is a wholly owned subsidiary of Saxo Bank A/S, headquartered in Denmark. Please refer to our General Business Terms & Risk Warning to consider whether acquiring or continuing to hold financial products is suitable for you, prior to opening an account and investing in a financial product.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Trading in leveraged products such as Margin FX products may result in your losses exceeding your initial deposits. Saxo Markets does not provide financial advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo Markets does not take into account an individual’s needs, objectives or financial situation.

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit www.home.saxo/en-sg/about-us/awards.

The information or the products and services referred to on this website may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and Services offered on this website are not intended for residents of the United States, Malaysia and Japan. Please click here to view our full disclaimer.

This advertisement has not been reviewed by the Monetary Authority of Singapore.

Apple and the Apple logo are trademarks of Apple Inc, registered in the US and other countries and regions. App Store is a service mark of Apple Inc. Google Play and the Google Play logo are trademarks of Google LLC.