WEST TEXAS INTERMEDIATE SURGES ABOVE 111 -- AIRLINES HURT BY RISING OIL PRICES -- DYNAMIC YIELD CURVE WAS FLAT IN OCTOBER 2007 -- STEEP YIELD CURVE BENEFITS BANKS AND ECONOMY -- 2-10 TREASURY SPREAD REMAINS WIDE
WEST TEXAS INTERMEDIATE SURGES ABOVE 111... Link for todays video. Weakness in the Dollar and strength in the stock market continue to support higher oil prices. John Murphy has spoken at length about the inverse relationship between commodities and the Dollar. This means one goes up when the other goes down. Oil could also be benefitting from a strong stock market. John also noted the positive relationship between stocks and commodities on Tuesday. Tensions in the Middle East and North Africa are also putting a bid into oil. West Texas Intermediate Continuous Futures ($WTIC) moved above $110 this week and Brent Crude moved above $124. WTI is the light-sweet oil used in the US. Brent is the North Sea oil used in Europe. Oil is moving higher on both sides of the pond. Chart 1 shows WTI Continuous Futures with nothing but uptrend. Oil broke out of a Diamond consolidation at the end of September and never looked back. The most recent surge started in mid February and first support is set at 85. The indicator window shows the S&P 500 moving higher along with oil since March 2009. Chart 2 shows the 12-Month US Oil Fund (USL) surging above 50. The uptrend just gets steeper and steeper. After a 10+ percent surge the last few weeks, USL is looking overbought and ripe for a pullback or consolidation. Chart 3 shows the US Gasoline Fund (UGA) in a strong uptrend.
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Chart 1
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Chart 2
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Chart 3
AIRLINES HURT BY CONTINUED STRENGTH IN OIL... Airlines remain under pressure after another surge in oil prices. I noted that the Amex Airline Index ($XAL) was at a potential support zone two weeks ago, but the index could not maintain its lift and failed to break resistance. Chart 4 shows the index firming around 42 in March and then breaking down to its March low with a sharp decline today. A falling price channel marks the current downtrend. With this weeks decline, we can set key resistance at 44. The lower trendline of the falling channel marks the next downside target around 38. Chart 5 shows the Guggenheim Airline ETF (FAA) moving below its March low with a sharp decline today. Southwest Airlines (LUV), United-Continental (UAL) and Delta (DAL) make up around 43.50% of this ETF. You can find more details at www.guggenheimfunds.com
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Chart 4
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Chart 5
DYNAMIC YIELD CURVE WAS FLAT IN OCTOBER 2007... There are basically three types of yield curve: normal, flat or inverted. A normal yield curve slopes up from the left (short maturities) to the right (longer maturities. Normal, or steep, yield curves are considered positive for banks and the economy. These are indicative of easy monetary policy from the Fed. A flat yield curve occurs when the yield on short-term Treasuries is roughly equal to the yield on long-term Treasuries. This happens when short-term borrowing costs rise to long-term levels. Flat curves send mixed signals on the economy. An inverted yield curve forms when the yield on short maturities (13-weeks to 2 years) is above the yield on long maturities (10-30 years). This is unusual because those holding short-term Treasuries receive a lower return that those holding long-term Treasuries. An inverted yield curve indicates that monetary policy is expected to tighten and the economy is expected to slow.
The next three charts are snapshots taken from the Dynamic Yield Curve. Chart 6 shows a slightly inverted yield curve in August 2006. The red line on the S&P 500 chart marks the Short-term rates were higher than long-term rates. Despite this inversion, stocks continued higher for another year. The Yield Curve was normal in 2003, 2004 and 2005. In fact, it was quite steep for the most of these three years. It took a year of an inverted or flat yield curve to finally weigh on the stock market.
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Chart 6
Chart 7 shows the Yield Curve at the October 2007 peak. Even though long-term rates were above short-term rates, you can see that short-term rates are relatively high and the yield curve is relatively flat. Less than 1% separated the 2-Year Treasury Yield ($UST2Y) and the 10-Year Treasury Yield ($UST10Y). 2-year Treasuries were yielding around 4% and 10-Year Treasuries were yielding around 4.65% around 11-October-2007.
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Chart 7
STEEP YIELD CURVE BENEFITS BANKS AND ECONOMY... Chart 8 shows current conditions and a very steep yield curve. 13-week Treasuries are yielding around .30% and 30-year Treasuries are yielding around 4.60%. Such a steep yield curve is beneficial to banks, which borrow short and lend long to capture the spread. Even though there is some debate on lending activity, the yield curve indicates that banks should be able to make money by lending money. This may also explain recent strength in the Finance SPDR (XLF) and the Regional Bank SPDR (KRE).
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Chart 8
2-10 SPREAD REMAINS VERY WIDE... The yield spread between 2-Year Treasuries and 10-Year Treasuries is perhaps the most watch pairing for clues on the yield curve. Chart 9 shows the 10-Year Treasury Yield ($UST10Y), the 2-Year Treasury Yield ($UST2Y) and the ratio of the two. Notice how this ratio was near 1 in the summer of 2007. This means 2s were yielding about the same as 10s and the yield curve was flat. That is Rick Santelli speak for 2-Year Treasuries (2s) and 10-Year Treasuries (10s). The ratio started rising at the end of 2007 and continued rising until early November 2010. The yield curve was at its steepest in early November. Even though the 2/10 ratio declined back towards 4, 10-Year Treasuries are still yielding four times more than 2-Year Treasuries, confirming the current steepness of the yield curve.
