This chart could be flashing a warning sign for the market
Credit spreads are widening and while this may not be a five-alarm fire yet, it's an omen for risk assets such as stocks, says one market strategist.
"There's no doubt that credit spreads are starting to widen out a little bit in the last couple of weeks, especially in the last few days," Matt Maley, equity strategist at Miller Tabak, told CNBC's "Trading Nation" on Tuesday. "That's usually a good leading indicator for a problem with risk assets."
The Markit CDX North American Investment Grade Index sharply has increased in March, adding to gains seen earlier in the year. The Markit index holds 125 investment-grade North American entities with high liquidity that trade on the credit default swap market.
"When spreads widen out, banks are a little less willing to loan money, but most importantly we also have a huge amount of leverage in the system," Maley said. "Rates move higher and especially if spreads widen out, people have to unwind some of that leverage."
Credit spreads widen when U.S. Treasury markets are favored over corporate bonds, typically in times of uncertainty or when economic conditions are expected to deteriorate. The spread measures the difference in yield between U.S. Treasury bonds and other debt securities of lesser quality, such as corporate bonds.
Maley does not see a repeat of 2016 when credit spreads were far higher than their current levels nor does he foresee levels seen during the financial crisis in 2008. However, widening credit spreads still act as a leading indicator for asset prices and are a signal worthy of attention.
"I don't want to start crying fire in a crowded auditorium but it's still something we have to keep an eye on," he said. "If they start to widen up further it's going to present a problem for many risk assets, not just the stock market."
Boris Schlossberg, managing director of FX strategy at BK Asset Management, agrees: the signs are flashing yellow, not red, at the moment.
"You could say it's simply correcting some of the excesses that we had in 2017 in terms of the blow-off moves in credit but on the other hand it's also suggesting that the market is starting to really get concerned about risk," he told "Trading Nation" on Tuesday.
The yield spread in bonds is telegraphing a similar shift in the market, says Schlossberg.
"The yields on a 2-year to 10-year are compressing," he said. "The market is basically anticipating a slowdown in economic growth rather than expansion in economic growth. All of those factors should be a big warning sign to investors."
The 2-year/10-year spread was at 54 basis points Wednesday and has been in a steady decline since earlier this month. A compressing yield spread and flatter yield curve usually suggest lower risk appetite among investors as they gravitate toward safe haven assets such as shorter-term bonds.
From CNBC