Wednesday, July 8, 2009

10 Year Treasury Yields: Serious Threat To Secular Trend Change

10 year Treasury yields were slaughtered today as the flight to safety unfolds amidst the stock market's decline. The 10 year Treasury yield is now below our monthly support level at a yield of 3.432%. See figure 1 a monthly price graph of the 10 year Treasury yield with the "next big thing" indicator in the lower panel.

Figure 1. $TNX.X/ monthly

The 10 year Treasury yield is an asset that I have identified as having the potential of undergoing a secular trend change, and I have documented my analysis numerous times since December, 2008. While the fundamentals (i.e., recession, deflation, rising unemployment) would favor lower yields and higher bond prices, the technicals are pretty straight forward. This is not the technical setup that would lead to a sustainable trend for higher bond prices (see: "Anatomy Of A Top"); this is a set up that leads to higher yields.

A monthly close over 3.432% was the technical confirmation that suggested yield pressures are in our future. This level was resistance, and it now should serve as support. Today was the first day since late May that yields on the 10 year Treasury bond closed below this support level. A monthly close below this level would put the notion of higher yields on the shelf for now.

Prospects for an economic recovery appear to be linked to rising Treasury yields. As hope for the economy grew, stocks were favored over bonds and yields rose. As hope has given way to economic reality, bonds are back in vogue. Historically, however, yields don't rise during a recession, and typically, yields don't rise well into a recovery. I discussed this in "Barron's Weighs In On Treasury Yields (Again!)". Nonetheless, it is my belief that yields will likely rise with any prospects of growth or hope of an economic recovery as yields are artificially low and the coil has been set. Of course, rising yields will choke off any recovery.

So let's summarize:

1) From a technical perspective, the 10 year Treasury yield has a high likelihood of undergoing a secular trend change; conversely, 10 year Treasury bonds are not looked upon favorably although they are in vogue over the short term as a flight to safety ensues.

2) May's monthly close over the 3.432% level confirmed a secular trend change in the 10 year Treasury yield.

3) Today, yields are below this level; a monthly close below 3.432% would put this notion of higher yields on the shelf.

4) As higher yields appear to be linked to better prospects for economic growth, a monthly close below the 3.432% level might be an ominous sign for equities and the "green shoots" recovery.

And in fact, we can look at the December, 2001 to June, 2002 time period to get a template as to what might unfold for equities and bonds. Please see the gray oval in figure 1. In December, 2001, yields closed above resistance levels at a time when the "next big thing" indicator suggested a secular trend change was likely; this is the price bar identified with the blue up arrows. Interestingly, the breakout in yields was the peak in the equity market, and this was the move from the 9/11 sell off.

Yields closed back below support at the end of June, 2002; this is identified with the red down arrows in figure 1. By this time, stocks had broken down, and in the following two months they went on to lose an additional 20% before hammering out a bottom. Figure 2 is a monthly graph of the S&P500. The yellow vertical line is December, 2001 or the breakout in yields. The red vertical line is June, 2002 or the break down (or reversal) in yields. What followed was not pretty for equities.

Figure 2. S&P500/ monthly


Anonymous said...

Deflation has to run its course first, and that could take a while. That is why your support line broke.

Dacian said...

Hi Guy,

I think the chances for your comparison to become true (today vs. 2001) are quite high. I think will have higher yields, but maybe the deflation is not completely done as the comment above states.

Very difficult markets indeed...

Dacian said...

Also there is good volume in bonds. This chart looks bullish for now.

Guy M. Lerner said...

A serious shot for now; yields are up today already ~3%....but not above our support/resistance level...we shall see by the end of the month

While I think yields are the place to be over the next 12 months, I don't see the converse as true - higher bond prices are facing stiff technical winds