What Are The Implications Of Rising World Interest Rates?

• -World Bond Index completes a major top.
• -US short-term bonds on the verge of a breakout.
• -Stocks now being threatened by rising rates.

World Bond Index

Global bond markets have really been taking it on the chin recently without that usual push they get from rising commodity prices. Monetary policy has been relatively easy, so the question that arises is whether bond markets are sensing a resurgence of growth later in the second half of 2015.

To offer an idea of how weak bond prices have been take a look at my Global Bond Index (!PRWBI) in Chart 1. This series is constructed from two ETF’s, the Barclays International Treasury (BWX) and the Barclays US Bond Aggregate, the AGG. Both are expressed in US dollars. The former consists of treasury bonds ex the US and the latter, as the name implies, consists just of US credit market instruments. For index purposes they have been weighted by their approximate share of world GDP. You can see how the Index has completed and decisively broken down from a giant head and shoulders top, but has yet to reach its downside objective. That suggests that world bond prices are headed lower and yields higher.

Chart 1

Momentum characteristics are bullish for yields

It would appear that the momentum is rising for yields. That view is being supported by both euro denominated German and yen denominated bonds featured in Charts 2 and 4. The German yield literally reversed on a dime and is back above its 65-week EMA and down trendline. The most remarkable feature of the chart comes from the incredibly overbought reading in the short-term KST.  Whenever you see a multi-year overbought reading such as this following a long bear market it almost invariably signals a basic change in trend. This particular extreme action is one of the most amazing things I have ever seen. It’s caused by the fact that the preceding relentless bear market in yields encouraged more and more market participants to go short. Lower yields begat lower yields until the bubble bursts and the shorts are forced to cover at any price to relieve the excruciating financial pain of greater and greater losses.

Chart 2

Good examples of this extreme momentum behavior that come to mind are the 1932 low in US equities. More recently the 12-day ROC of the gold price reached a seventeen-year high at the 1999 secular low (Chart 3). In the case of US equities prices worked their way irregularly higher but in gold’s case, they retraced almost all of the rally prior to really starting on their new secular uptrend in earnest. The characteristics may have been different, but in both cases a mega change in trend was signaled.

Chart 3

Chart 4 shows that the Japanese 10-year Government Bond yield ($JPT10Y) has completed a double bottom, violated its down trendline and lifted itself above its 65-week EMA. All these trend signals indicate a reversal from bear to primary bull.

Chart 4

The JP Morgan Emerging Market bond ETF, the EMB has been plotted inversely in Chart 5 to correspond with movements in yields. It has not broken out yet but the rising KST suggests that it soon will. A move in this inversely plotted series through $106 would do the trick.

Chart 5

US bonds

Returning to the US, Chart 6 shows that the 12-week ROC for the 30-year yield ($TYX) experienced an extreme momentum phenomenon in 2008. In this case the bear market reached a crescendo by registering a multi-year low in the ROC, which was then quickly followed by a record high. This kind of action is known as an extreme swing. You can see a bearish extreme swing at work in Chart 3 featuring the gold price. Since it is so unusual and reflects a huge change in sentiment extreme swings are usually followed by a major trend change lasting many years. This is a particularly impressive one and may well signal a reversal in the secular bear trend that began in 1981. In this instance we have seen two subsequent tests of that 2008 low. It’s true that those lows were temporarily breached earlier in the year. In recent weeks though the yield has rallied back above the level of the 2008 and 2012 lows, and that suggests that the bullish yield message being given by the extreme swing is still in force.

Chart 6

Chart 7 features the 20-year yield ($UST20Y), and here we can see what it would take to reverse the secular downtrend in yields that began in 1981. The two indications I am looking for would be a rally above the 96-month MA, which is currently in the 3.5% area and a break above the green down trendline at just under 3.9%. Right now the KST is bearish, but in the event of an upside break above the MA, that KST would likely have already reversed to the upside.

Chart 7

Chart 8 shows the Moody’s Corporate BAA yield. In this instance it has already broken above its multi-year down trendline and the KST has reversed to the upside. That kind of action strongly argues in favor of higher yields.

Chart 8

Shorter term maturities have been less strong than their longer-term counterparts. For example the 1- and 2-year treasury yields have only just begun to break to the upside, as you can see from Charts 9 and 10.

Chart 9

Chart 10

Finally, the 5-year yield ($UST5Y) is sandwiched between the short and longer term maturities and has been in a trading range for some time. We would look for a daily close above the two green trendlines to signal an important breakout. That would come with a close above 1.85%. Note that the long-term KST is still in a declining mode which somewhat clouds the issue. However, if the yield does move above 1.85% that would take precedence because, as we say, “trend trumps everything.”

Chart 11

And what about equities?

Throughout the ages rising interest rates have been poison for equities. Our final chart compares the MSCI World Stock ETF, the ACWI, with my own A/D Line constructed from a basket of country fund ETF’s as well as the World Bond Index. Note that the A/D line has been diverging negatively with the ACWI for several months and has now broken below a key up trendline. You can also see that the (Bond Index !PRWBI) has been diverging for an even longer period.  In 1987 a very powerful rally looked like it would never end, but a quick telephone call from the bond pits indicating that yields were surging, was followed by the famous crash. I am certainly not forecasting a crash now because there is no way of predicting when confidence for some reason or another implodes. What I am saying is that we already have a breakdown in the A/D Line and in the global bond markets. Stocks look like they may be in the process of confirming such action as they have already violated key up trendlines and are close to violating others. Consequently, it may be time to take some chips off the table before we get any more telephone calls from the bond pits!!

Chart 12

Good luck and good charting,
Martin Pring

The views expressed in this article are those of the author and do not necessarily reflect the position or opinion of Pring Turner Capital Group or its affiliates.