BOND YIELDS HAVE BOTTOMED -- THAT'S BOOSTING THE DOLLAR AND PUSHING COMMODITIES LOWER -- THE IMPACT ON STOCKS IS LESS CLEAR
BOND YIELDS BREAKOUT TO THE UPSIDE ... On May 13 and 15, I wrote about bond yields forming an apparent "double bottom" pattern and in the process of turning higher. To confirm that view, yields had to exceed their February highs. Charts 1 shows the 10-Year Treasury Note Yield hitting a new high for the year and clearing its 200-day moving average in the process. Chart 2 shows the 30-Year T-Bond Yield reaching a seven-month high. The fact that bond yields are bouncing off major support formed during 2003 increases the odds that long rates have hit a long-term bottom. The most obvious impact is on bond prices which fall when bond yields rise. Charts 3 and 4 show two bond ETFs breaking chart support and their 200-day lines. Although the TIPS Bond Fund has held up a bit better, it's under heavy selling pressure as well. There are two factors boosting U.S rates. One is today's report that first quarter GDP was better than expected (+0,9%). The more important reason is rising global inflation. My May 13 Message suggested new inflationary pressures from Asia could be signaling the end of the low inflation era. That would suggest that the era of low interest rates is ending as well.
Chart 1
Chart 2
Chart 3
Chart 4
Chart 5
RISING RATES BOOST DOLLAR... My May 15 Message showed that the U.S. Dollar Index was at the most oversold level since 2003 (the last time bond yields bottomed). I also pointed out that the dollar usually follows the direction of U.S. rates. Over the last year that trend has been down. Not it's up. One way to tell that the dollar is rising is foreign currencies are falling. That's especially true of the Euro. The daily bars in Chart 6 show the Euro falling back below its 50-day moving average after failing a try at its April high. A drop below its May low would be a further sign of weakness. The monthly bars in Chart 7 show the Euro at the most overbought level in five years. Chart 7 also shows the Euro trading well above its 20-month moving average (middle line). That leaves plenty of room for the Euro to drop and the dollar to rise.
Chart 6
Chart 7
A RISING DOLLAR HURTS COMMODITIES ... Commodity prices usually trend in the same direction as the Euro and in the opposite direction of the dollar. That means that recent intermarket trends have turned against commodities. That explains the past week's heavy selling of gold and most other commodities. Only energy has held up. My earlier messages showed this same chart to demonstrate every commodity group outside of oil already in a downside correction. The main reasons for those corrections are rising interest rates and rising dollar. It's just a matter of time before energy succumbs to profit-taking as well.
Chart 8
THE IMPACT ON STOCKS IS LESS CLEAR ... As I suggested earlier in May, the impact of rising rates on the stock market is less clear. Over the short-run, it would seem to benefit stocks since some bond money would normally find it way back into stocks. Figure 9 shows bond and stock prices trending in opposite directions over the past year. Some money coming out of gold and other commodities should also find its way into stocks. A drop in crude oil prices should help stocks as well. As I noted on May 13, however, rising rates could lead to longer-term problems for stocks. In the low inflation environment that's existed since 1998 when deflation was exported from Asia, bonds and stocks have been decoupled. In that environment, rising rates actually helped stocks. If we're entering a new inflationary era (also coming from Asia) rising rates may start to hurt stocks. In other words, bond and stock prices may start to recouple as they've done throughout most of history.
Chart 9
