Bond Markets Flashing Warning Signs Now That Fed Is Tightening

The above chart from the St. Louis Fed shows two important facts about the bond market:

First, the blue line shows the spread between “high yield” (sometimes known as “junk”) bonds and Treasuries. Note that it is currently the highest it’s been since the crisis subsided. We are in dangerous waters.

Second, the red line shows the “monetary base,” a measure of the amount of money that the Fed has injected into the financial system. Notice that the Fed has been able to beat down the blue line (in other words, get investors to hold riskier bonds for lower yields) through the various rounds of QE. But once that monetary stimulus stopped, the spread between risky and safe bonds started rising, and it has shot way up since the Fed began hiking rates in December. (The rate hike partially involved “reverse repo” operations which have the effect of reducing the measured monetary base.)

The above chart is consistent with our view that the Fed has simply postponed the needed adjustments from the 2008 crisis, and indeed is setting us up for an even bigger crunch.