When it comes to the economy, all roads lead back to the Fed… More specifically, interest rates.

Any time the Federal Reserve moves rates, it has a direct effect on all consumers… from their mortgage to car loans. And that all flows into the broader economy.

However, what’s not always obvious is how a change of interest rates affects the flow of money between assets.

For example, when interest rates start to fall, money flows into riskier assets (like junk bonds) as investors chase higher returns (yields).

Now, with interest rates about to rise, money is starting to flow back into assets like government bonds.

Last week, I discussed this pattern and its impact on the iShares iBoxx $ High Yield Corporate Bond ETF (HYG) marked by the red arrow below.

Today, I want to update you on this chart because after the recent price action, HYG is starting to look interesting…

iShares iBoxx $ High Yield Corporate Bond ETF (HYG)

Source: eSignal

When we checked out HYG, it had been in a downtrend since September. Having hit its 2021 peak (1), it then made lower highs at ‘2’ and ‘3’.

Each of these moves were punctuated by dips in the Relative Strength Index (RSI – lower half of the chart). At both ‘A’ and ‘B’, the RSI fell into oversold territory (below the lower grey horizontal line), before forming a ‘V’ and sending momentum (and HYG’s share price) back higher.

With the RSI again closing in on oversold territory (on January 24), HYG was about to face an important test…

I was looking to see if HYG could hold a key support level (green line). A break below that would add further weight to the emerging downtrend.

HYG not only broke support, but went on to fall to its lowest level since November 2020. Now it’s scraping around its 15-month lows.

I also looked for growing divergence between our moving averages (MA). When that happens, it gives further proof that a move in either direction is gaining momentum.

Since we looked at HYG, the 10-day MA (red line) has been accelerating away from the 50-day MA (blue line) – adding to the bearish sentiment.

However, action over the next few days will be critical in what direction HYG takes from here…

So, let’s take another look at the chart…

iShares iBoxx $ High Yield Corporate Bond ETF (HYG)

Source: eSignal

The RSI has recently formed a ‘V’ (marked C) and is showing HYG as oversold again. So, a bounce (however brief) could soon be in the cards.

If HYG bounces, then its first test will be to see if it can rally back up to that green line.

(A previous support line can change into resistance once a price breaks through it – and vice versa.)

However, if HYG fails to break above the green line – meaning that previous support level has become resistance – then that’ll also mean that HYG has made another lower high.

And, that would further confirm a downtrend. From there, we could expect HYG to re-test its January 28 low as that downtrend gains momentum.

When a stock falls like HYG has, you can always expect a bounce. The deciding factor is how strong that bounce will be.

If HYG bounces but runs out of momentum, we need to be ready to sell into any strength.

Regards,

Larry Benedict
Editor, Trading With Larry Benedict

Reader Mailbag

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