Risk On or Risk Off? Watch the Bond Market

• Posted by Greg Harmon
• on October 26th, 2011

The ratio of Treasuries to High Yield Bonds is used by many to get an indication of of the markets broad appetite for risk. Since High Yield Bond prices have a strong correlation to stock prices it is also used as a proxy for the stock market. So what does the ratio say today about the future of the Risk Trade? Let’s take a look.

The ratio chart above of the iShares Barclays 20+ Year Treasury Bond Fund, $TLT, to the SPDR Lehman High Yield Bond ETF, $JNK, has a lot to say. First, the ratio is sitting on support at the previous bottom at about 2.95. It printed a bullish engulfing candle, which if confirmed would signal a reversal higher. The Relative Strength Index (RSI) which has remained bullish, is also looking like it is reversing higher, supporting a move higher in the ratio. But the Moving Average Convergence Divergence (MACD) indicator has been trending lower towards a negative cross. The Exponential Moving Averages (EMA) that comprise the MACD may be ready to glance off of each other rather than cross though to negate that. The entire run to the high was done on decreasing volume which reinforces the drop due to a weak advance. And it is now at the 38.2% retracement of that move which could explain a pause.

The ratio and indicators are painting a mixed picture and this is leading to difficulty in assessing the broad market appetite for risk for more than a couple days at a time. If this ratio were to jump higher over 3.05 it would signal ‘Risk Off’ and a drop below 2.90 ‘Risk On’. Continue to watch this ratio for hints as to the future of the markets.

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