Tuesday, November 25, 2008

Long Term Treasury Yields

In recent commentaries, I suggested that long term treasury yields had the technical characteristics of an asset class where a long term secular trend change could be at hand. The prime fundamental driver would be that the U.S. government would need to make its sky rocketing and newly issued debt more attractive to its foreign buyers. So far this trade, which I had expected to last at least 18 months, has not worked out.

This past month, Treasury yields have dropped (as bonds have risen). This is essentially the flight to quality and liquidity trade. As stocks do poorly, bonds have defied the skeptics and risen in price. Or to put it another way: when folks wonder how low can stocks go, they also should be wondering how low yields on the 10 year Treasury can get. Yields are within a stones throw of their all time low.

The technical set up that has been reversed can be seen in figure 4 a monthly chart of the 10 Treasury yield. The indicator in the lower panel is our “next big thing” indicator that seeks to identify those times when a secular trend change is highly likely. Last month, Treasury yields closed above the 10 month moving average and above a down sloping trend line. This seemed to be confirmation that the trend for yields was reversing. One month later, yields have reversed lower to close below the 10 month moving average, the trend line and below a pivot low point (marked with red arrows) that should have served as support. This level comes in at 3.432% yield and now represents resistance. A monthly close above this level would mean that Treasury yields are likely to move higher.

Figure 4. Long Term Treasury Yields/ monthly

The only technical positive is the possibility for a double bottom, which I have highlighted before. Yields could reverse at this level, but confirmation of a reversal would only take place on a monthly close above resistance at 3.432% .

Extrapolating bond market strength to stock market weakness, one might suggest that lower yields (higher bond prices) continue to imply ongoing flight to quality and flight to liquidity. In other words, stocks aren’t expected to rise as long as money flows into bonds. As hard as it is to believe, bonds remain attractive. The yield is not attractive but in this deflationary environment they are attractive. Treasury yields are still on the cusp of a secular trend change, but it appears we will need to wait a little bit longer for yields to move higher. The price action does not suggest higher yields anytime soon.

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