TEN-YEAR TREASURY YIELD REMAINS IN SHORT-TERM PULLBACK -- IT'S BEING HELD BACK BY EVEN WEAKER FOREIGN YIELDS -- THAT EXPLAINS RECENT WEAKNESS IN FOREIGN CURRENCIES -- COMMODITY PRICES CONTINUE TO STRENGTHEN
TEN-YEAR TREASURY YIELD IS PULLING BACK ... After reaching the highest level in seven months during October, the 10-Year Treasury Yield ($TNX) has experienced a pullback. Chart 1 shows, however, that pullback in the TNX over the last two weeks hasn't been enough to reverse its general uptrend. It remains above initial chart support formed in mid-October at 2.27% (flat line). In addition, the TNX remains above its 50- and 200-day moving averages (although it's in the process of testing the latter). A lot of reasons have been given for the pullback in yields, including doubts about a quick passage of the tax package in Congress and the naming of a new Fed head viewed as dovish. I suspect an even bigger reason for the pullback is that foreign developed bond yields are dropping even faster. That's pulling Treasury yields lower. The 10-year Treasury yield has dropped 5 basis points over the last month. By comparison, 10-Year yields in Germany and the UK have lost -14 and -16 basis points respectively. Canada's 10-Year yield has dropped -24 bps. Falling foreign yields increase the demand for higher-yielding Treasuries. That suggests that the current pullback in Treasury yields may have more to do with more dovish policies in foreign markets than what's going on in the U.S. Those bigger foreign yield drops are reflected in losses in their respective currencies against the dollar.
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Chart 1
LOWER BOND YIELDS WEAKEN FOREIGN CURRENCIES ... Chart 2 shows declines in the currencies of Britain, Canada, the eurozone, and Japan over the past couple of months. The Euro (blue line) has lost nearly -4% since September, while the British Pound (red line) has dropped -3.5%. The Canadian Dollar (green line) has lost -4.5%. Those declines are due mainly to the fact that their bond yields have lost more ground than Treasuries over that time period (or, in the case of Japan, have stayed down throughout the entire period). Japanese bond yields are anchored near zero. That also explains why the Japanese yen (orange line) has been weaker than the other currencies. The yen (orange line) is down -5.1% since early September. Japan still has the most accomodative monetary policy. That's helped push Japanese stocks to the highest level in 25 years. One reason foreign central bankers favor weaker currencies is because that raises the prices of commodities quoted in local currencies, and helps boost inflation.
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Chart 2
COMMODITIES CONTINUE TO STRENGTHEN ... Last Wednesday's message showed the Bloomberg Commodity Index ($BCOM) reaching the highest level in eight months. That was attributed mainly to a four-year high in some base metals, and a nearly two-year high in WTIC crude oil. Since then, WTIC crude oil has risen to the highest level in more than two years. The weekly bars in Chart 3 show $BCOM climbing again this week. A big question for investors is whether commodity prices as an asset class have finally hit bottom after nearly a decade of weakness. If that's the case, rising commodity prices could start to play a bigger role in asset allocation strategies. Over the past decade, deflationary forces have been a huge drag on commodity prices. In addition, unprecedented monetary easing by global central bankers has kept interest rates at historically low levels, and has helped push global stocks to record highs. A bottom in commodities, however, could start to impact at least one other asset class. That would be bonds.
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Chart 3
DEFLATIONARY INFLUENCE MAY BE LIFTING ... One of the basic intermarket principles that has held up for decades is that bond prices and commodities usually trend in opposite directions. That's because commodity direction is viewed as a barometer of inflationary (or deflationary) trends. The brown bars in Chart 4 show the Bloomberg Commodity Index peaking in 2008 in the midst of the financial crisis (eight months after stocks peaked). Commodities then rose with stocks between 2009 and 2011. Since then, it's been all downhill for them. The green line in Chart 4 tracks the price of the 30-Year Treasury Bond ($USB). Bonds rallied during 2008 (as stocks and commodities weakened). Bonds sold off during 2009 as the two other asset classes rallied, and remained relatively flat between 2009 and 2011. The drop in commodities, however, between 2011 and 2015 coincided with a strong uptrend in bond prices. But things started to change during 2016. Commodities bottomed at the start of 2016. Since then, they've advanced nearly 12% as a group. Bond prices peaked in the middle of 2016 and have lost -10% since then. That may be an early hint that a potential bottom in commodities is contributing to a long-term top in bond prices.
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Chart 4
COMMODITY/BOND RATIO MAY BE BOTTOMING... The brown line in Chart 5 is a relative strength ratio of the Bloomberg Commodity Index divided by the 30-Year Treasury Bond Price. The chart shows the ratio bottoming at the start of 2016. A second bottom in the middle of this year is keeping it rising (second up arrow). For the record, that's the best relative performance of commodities to Treasury prices since the period between 2009 and 2011. [Or, put the other way, the worst relative performance of bond prices versus commodities]. There may be a warning in Chart 5, and an opportunity. The warning is for bonds, and the opportunity in commodities. The strongest synchronized global economy in a decade is starting to increase demand for economically-sensitive commodities like industrial metals and energy. That's being reflected in rising commodity price indexes. That's usually an early sign that inflationary pressures are starting to build in the commodity pipeline. Rising inflation usually hurts bond prices. We may still be in the early stages of a transition out of the deflationary climate that helped bonds and hurt commodities over the past decade. But the transition appears to have started. The party may be ending for Treasury bond prices. But it may just be starting for commodities. Especially commodities tied to the strengthening global economy. And stocks tied to them in basic materials and energy sectors. An upside breakout in crude oil has made energy one of past week's strongest sectors.
