When the Fed started increasing interest rates, the value of existing bonds took a hit.
That’s because investors sell existing lower-yield bonds to take advantage of newly issued bonds’ higher yields.
But it wasn’t just government-issued bonds feeling the squeeze…
The iShares iBoxx $ High Yield Corporate Bond ETF (HYG) fell heavily. This ETF invests in high-yielding corporate bonds from companies like Ford Motor Credit and Caesars Entertainment.
After bottoming out, though, HYG began trading in a sideways range this year.
It continued this movement right until the Fed’s “higher for longer” message at its September meeting. After that, HYG took another leg lower.
But HYG has recently experienced a strong bounce. So I want to check out what’s coming next…
Fed Watching
After it bottomed in October 2022, HYG went through dramatic swings from November to February.
From there, HYG transitioned into a sideways pattern:
iShares iBoxx $ High Yield Corporate Bond ETF (HYG)
Source: e-Signal
During this sideways period, the longer-term 50-day moving average (MA, blue line) traded flat.
Yet the 10-day MA (red line) crossed it multiple times in both directions. Those swings were minor, though.
Additionally, pay attention to the lack of action in the relative strength index (RSI).
It zigzagged along the support/resistance (green line) without a definitive move in either direction.
But that all changed when the Fed met on September 20.
HYG gapped lower due to the “higher for longer” interest rates narrative. Then the stock fell through late October. This move coincided with the RSI breaking strongly lower.
Adding to the bearish sentiment, the 10-day MA crossed and accelerated below the 50-day MA.
But there were signs that HYG was oversold even before the Fed’s most recent meeting last week.
Take another look:
iShares iBoxx $ High Yield Corporate Bond ETF (HYG)
Source: e-Signal
As you can see, both the RSI and HYG stock prices were converging (orange lines). This is a common pattern that often leads to a reversal.
HYG’s down leg bottomed and reversed with the RSI rallying back up toward resistance.
Then HYG gapped higher off the back of a jump in government bonds.
This happened, at least in part, because of the perceived softening of the Fed’s stance on future rate rises.
Also, the Treasury reduced the size of its bond offering. The market interpreted this as a sign that the tightening cycle may be ending.
This move even had some people (falsely) thinking that the Fed would cut rates soon.
So after HYG’s bounce, what am I looking for next?
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Filling the Gap
The big jump last week put the RSI close to overbought territory (upper gray dashed line).
HYG “closed the gap” that opened after the Fed’s meeting back on September 20.
After such a short, sharp burst, though, it will be difficult for HYG to sustain the momentum to develop into a proper rally.
And that’s why I’ll be watching the RSI closely from here.
A sharp reversal could see the RSI testing support (green line) soon. HYG could quickly roll over.
Beyond that, if the RSI moves back into its lower band, we could see HYG fill in the gap created after the Fed’s meeting last week.
Regards,
Larry Benedict
Editor, Trading With Larry Benedict
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