Wednesday, August 26, 2009

Long Term Treasury Yields: Someone Is Going To Be Wrong

For over 8 months now, I have been chronicling the plight of the 10 year Treasury bond. Based upon the "next big thing" indicator it was my expectation that yields on the 10 year Treasury bond would rise once there was a monthly close above a yield of 3.342%. This occurred at the end of May, 2009.

See figure 1 a monthly chart of the yield on the 10 year Treasury bond. The "next big thing" indicator is in the lower panel, and the close over the "key" pivot low point is identified with the blue up arrows. Once this technical metric was met within the confines of the "next big thing" indicator being in the position where we would expect a secular trend change, it was my expectation that this would result in higher yields over the next 12 months.

Figure 1. $TNX.X/ monthly

Technically, the set up is there, but the fundamentals for higher yields have always been questionable. Some of the fundamental headwinds for higher yields include: 1) rising unemployment; 2) a deflationary environment as reflected in 50 plus year low in CPI; 3) an economy that has "leveled out" but that has yet to demonstrate any real growth. Despite the technical signal 3 months ago, the fundamentals have not appreciably changed. Furthermore, the Fed's back stopping of the bond market has put an unknown bid behind Treasury bonds.

Treasury yields did "pop" to 4.014% in June, but there has not been any follow through, and looking back to figure 1, we note that Treasury yields are sitting just above support.

But here is the point: Treasury yields have not moved higher; in other words, the Treasury market is not discounting the economic recovery. On the other hand, the stock market has roared ahead discounting the recovery (and then some). This divergence is noticeable, and it appears someone is going to be wrong.

Now let's drill down and look at a weekly chart of the 10 year Treasury yield. See figure 2. The pink markers over the price bars are negative divergence bars, and we note a cluster of these suggesting that upside momentum has been severely curtailed.

Figure 2. $TNX.X/ weekly

I had previously pointed out (see: "How Will We Know If The Secular Trend In 10 Year Treasury Yields Is For Real?") that such a cluster of negative divergence bars was an ominous sign for higher yields. See figure 3, a weekly chart of the 10 year Treasury yield. The indicator in the lower panel counts the number of negative divergence bars occurring over the prior 13 week period. When the indicator is red, it means that there are at least 3 negative divergence bars occurring over a 13 week period. As you can see, the prior 5 times going back to 1987 generally marked the top in 10 year Treasury yields; prior to 1987 (and not shown on the chart), there were 2 other occurrences - one resulted in a big sell off while the other was mild. So we should respect this pattern!

Figure 3. $TNX.X/ weekly

But let's take a closer look at figure 2. A weekly close below a yield of 3.437% would be a sign of lower yields within the context of these multiple negative divergence bars. Furthermore, the breakout from the channel would be a failure, and the blue up trend line would be broken. Technically, the 10 year Treasury yield is looking into the abyss of a failed signal. A monthly close below the 3.342% would be further confirmation of lower yields.

Two other points are noteworthy. One, a failure of this signal does not necessarily imply a secular trend change for Treasury bonds; they may be good for a trade but I don't see a secular trend developing from these low level of yields. Two, a failed signal in Treasury yields has a reasonable chance of signalling the top in equities. In other words, the divergence between lower yields - a sign of economic weakness - and higher equity prices - a sign of economic strength - will not persist for long. Most importantly, it was the failed signal in June, 2002 that coincided with a 25% plus drop in equities over the next two months. It should be noted that the current set up in Treasury yields and likely failure is exactly the same as in 2002!

Figure 4 is a monthly chart of the 10 year Treasury yield compared to the S&P500 (lower panel), and the failed signal in 2002 is highlighted in the oval.

Figure 4. $TNX.X v. S&P500/ monthly

To summarize, technical weakness seems likely in 10 year Treasury yields. This is sign of economic weakness and it is at divergence with the strength in equities. It would seem likely that this divergence will not persist for long. The current set up in 10 year Treasury yields is reminiscent of 2002, and it should be noted that a failed signal in the 10 year Treasury yields led to a significant down draft in equities.


Dacian said...


This vehicle here might be another argument that credit markets are not confirming the last leg up in equities. I don't know how right historically about the economy: equity or credit markets?!

Steve said...

I believe in general the bond market is smarter than the stock market, so in the end, the bond market will be proven right. The public in general does not actively trade the bond market. This removes a lot of the so-called "dumb money".

Anonymous said...

is any tech analysis even valid now? with gov buying its own debt and other insanity going around... hows that gonna make sense on the TA?

Guy M. Lerner said...

Anonymous: fair question.

My response: if gov't is buying its own debt or someone else buying why wouldn't it show up in the price charts? We are just looking at prices.

But why pick on TA? All analysis is invalid if there is someone standing there with a printing press and artificially back stopping prices everytime it looks like there might be a down trend.

Think about it this way: what you are saying is that prices will only ever go up, and despite what we read and feel, I have a hard time believing that. If "they" and I am not sure who "they" is can push prices up 50%, then why not 100% or 500%. If these are real imbalances, then they will be corrected.

dacian said...


Anon's question is valid as you say: prices are sending signals and informations to investors/entrepreneurs in a free market; when they are distorted by the government (or intense speculation - yes, that can too create big distortions) it's becoming very difficult to navigate (actually it's becoming volatile and more like a casino rather than based on rational decisions; I know market is irrational, but many investors out there try to base their decisions on rational thinking). It's sad, but this is where we are.

Dalamar said...

Why debt is not going up even if the goverment buys it?

May be because there is a huge amount of new debt in the market...

Why stocks go uo but no bonds?

Becacuse bonds are financing the bailouts of the stocks...

tv said...

A supporting cast for Treasuries

Guy M. Lerner said...

TV Said:

Thanks for the excellent link!!

Anonymous said...

DOW / SP500 / FTSE daily chart shows increasing topping action.

Weekly chart remains bullish so far ...

Monthly chart remains bearish.

more here