With downside volatility picking up this week, some of you might be wondering if we are on the cusp of a significant market downturn, or is this just another dip that buyers will eventually step into?
It’s worth remembering that every big move starts small, but not every small move turns into something bigger.
That’s where credit spreads come into play—they act as a reliable barometer of market health, offering insights into investor sentiment and risk appetite.
One effective way to measure them is by analyzing the ratio of the High-Yield Bond ETF $HYG to the Treasury Bond ETF $IEI.
When investors are willing to take on more risk, this ratio typically trends higher. On the other hand, when caution takes over and safety becomes the priority, credit spreads widen, and this ratio declines.
Currently, the HYG/IEI ratio is at a critical juncture.
After breaking out of a multi-year base earlier this year, it’s now pulling back to retest that breakout level.
If HYG/IEI holds above this area of former highs and begins to rebound, it would signal that the recent pullback in equities is more likely a buying opportunity than the start of a deeper decline.
However, if the ratio breaks back into its prior range, indicating a failed breakout, it could spell trouble.
After all, if there is real stress in the market, you're going to see it in credit.
Keeping a close eye on this relationship will help us determine whether the current volatility is a blip or a broader warning sign.
