Next larger move in markets very well could be lead by this indicator
The following chart is the spread between the average BAA corporate interest rate and the 10 year US Treasury rate. As can be seen by the red circles persistent expansions of the interest rate spread above its moving average line have consistently been associated with significant broader market selloffs. The lone green circle on this chart illustrates the beginning of periods where persistent contraction of the interest rate spread below it’s moving average line have consistently been associated with significant broader market rallies.
The most recent month has been a time of increasing liquidity stress, which means it is more difficult to get money. Corporate interest rates have remained fairly stable, only dropping (from 6.51% to 6%) 7.8% while 10 Year US Gov’t Treasuries interest rates actually dropped (from 4.01% to 3%) 25.2% As is illustrated by the following chart. During times when financial events, as opposed to economic cycles, drive Gov’t rates, US Gov’t Treasuries typically lead corporate rates in an inverse relationship. As economic stress picks up, US Gov’t interest rates drop. If that stress passes (sometimes just temporarily), as with the Europe credit crisis so far, then corporate rates remain fairly stable and US Gov’t rates drop and then typically revert back. The junction we find ourselves at, presents two ways: one way could be that US Gov’t interest rates revert back up, or corporate rates drop and close the spread exhibiting reduced financial risk stress, or the stress being exhibited by US government slowly bleeds into corporate bonds, further increasing the spread by forcing corporate rates higher. Time will cure this question.
