By: Elliot Turner
This morning, 20-year Treasury Bonds–as represented by the TLT–opened just above the 50-day moving average and sitting on the wedge it had recently broken out of. After an attempted down move, Treasuries proceeded to rally back towards unchanged. This was the first test of the breakout area since last Friday’s breakout. Investors continue to seek the safety provided by Treasuries despite the market’s persistent push higher.
If Treasuries continue to hold the breakout area, I would look for some pain in corporate bond markets. With that being said, I wanted to take a look at high yield/junk corporate debt (as represented by the HYG) as another gauge for bond market health. Unlike equity markets, which thus far have mostly recouped their late January and early February losses, high yield debt remains stuck at its 50-day moving average, which just so happens to coincide with the 61.8% retracement level of the move from the early January highs to the early February lows.
All in all, with an economy shifting from a long-term secular expansion in leverage to a contraction, the quest for liquidity is leading investors to government debt and equities. Since the March bottom, debt market reflation has helped fuel the rally in equity markets, but maybe now we are seeing the secular conversion of debt to equity (or the capitalizing of debt) play out on a much larger level. A consistent theme in the spate of recent takeover talks across a multitude of sectors is that companies with strong cash positions are taking over companies with weak debt structures. Such transactions are deflationary in that they replace existing debt with actual cash.
The prior strength in debt markets might have been a reflection of the Fed’s intervention in order to prop up bond markets with a variety of tactics, including outright purchases of MBSs. The government ultimately shifted a significant chunk of private sector debt to the public with both Fed and government intervention. With the Fed’s purchases soon coming to an end, maybe now is the natural time for equity to take a leadership role over debt. I will continue to watch this relationship in order to gain a clearer perspective on debt and equity markets moving forward.
