FALLING BOND YIELDS REFLECT MONEY MOVING OUT OF STOCKS AND INTO BONDS -- FALLING RATES ALSO HURT THE DOLLAR AND ARE HELPING GOLD -- REITS ARE ALSO ATTRACTING NEW MONEY
BOND YIELDS CONTINUE TO DROP ... Whether or not it's based on fears of a slowing economy -- or today's relatively benign core PPI inflation report -- bond yields are falling sharply as bond prices rise. Chart 1 shows the 10-year T-note yield falling further beneath its 200-day moving average. When bond yields fall, prices rise. Chart 2 shows the T-Bond 7-10 year ETF (IEF) rising to the highest level in nearly two months. Chart 2 is a mirror image of Chart 1. The ratio at the bottom of Chart 2 is the IEF divided by the S&P 500. The ratio has risen to a new 2005 high, which simply shows that money coming out of stocks has been going into bonds.
Chart 1
Chart 2
FALLING RATES COULD HURT THE DOLLAR ... The drop in bond yields could have a ripple effect through other markets. For one thing, lower U.S. yields may be starting to hurt the dollar. Chart 2 compares the 10-year T-note yield (bars) to the Dollar Index (green line). The rise in bond yields starting in November of last year helped support a dollar bottom a month later. Rising rates were supportive to the dollar during the the first quarter. The recent drop in bond yields, however, is starting to weaken the dollar which is backing off from its first quarter high (and its 200-day moving average). That explains why gold is suddenly rallying.
Chart 3
GOLD BENEFITS FROM FALLING RATES... It may seem strange to describe gold as a rate-sensitive market. But that is the case. Rising rates strengthen the dollar which hurts gold. That's been the case since last December. Falling rates weaken the dollar which boosts gold. That's what's happening now. Chart 3 compares the yield on the 10-year T-note (bars) to the price of gold (gold line) over the last year. The chart shows that they generally trend in the opposite direction. The peak in bond yields last June coincided with a gold upturn. The November rally in yields led to a downturn in gold within a month. The recent downturn in bond yields is starting to push gold higher.
Chart 4
WHAT'S THE FED TO DO ... The recent turn of events raises some interesting problems for the Fed. Expectation of higher interest rates to contain inflation put a damper on gold and other commodities which have corrected downward. The recent slide in the stock market, however, signs of economic slowing, and a benign inflation report are raising hopes that the Fed may stop tightening for awhile to stabilize the market and the economy. If it does, bond yields could drop further which would weaken the dollar and push commodity prices higher again, which would be inflationary. An interesting problem for the Fed. Our job is a little easier. We just follow the lines on the charts. Right now the lines favor bonds over stocks, and gold over the dollar. Chart 5 shows the Gold ETF (GLD) trading over $5.00 higher today and back over its 50-day moving average. Nervousness about the stock market may also be pushing money back into gold and gold stocks. That makes gold and bonds two of the primary beneficiaries of the recent market slide. REITs may also be benefiting.
Chart 5
REITS ARE STARTING TO DO BETTER ... The REIT market is also sensitive to the direction of interest rates. Chart 6 shows the Morgan Stanley REIT Index having peaked at the end of December and falling throughout the first quarter. The group is starting to stabilize, however, above its January low and its 200-day moving average. The relative strength ratio along the bottom of the chart has also turned up during April. Lower rates and a weaker stock market are making REITs a more attractive alternative at this point as well. The fact that REITs pay high dividends doesn't hurt either.
Chart 6
