The Technical Case For A Major Reversal In Bond Yields

Two charts that may soon look to the bullish side for rates

Short-term technicals

Watch those metals

In the last 35 years, analysts and investors have gotten used to seeing ever lower rates, even negative ones in Europe and Japan. It seems to me that things may be getting out of hand. Take a look at Chart 1 featuring a leveraged Japanese government Bond ETF (JGBT). It’s clearly in a dangerous and unsustainable rise.

Chart 1

According to Bloomberg, there are now close to $9 trillion of securities worldwide with yields below zero. The talk of negative rates has also spread to the US, with Fed Chairwoman Janet Yellen failing to  “take them off the table” at a recent congressional hearing. With a background like this, it would seem highly unlikely that rates are about to experience a primary trend rebound to the upside. Yet the charts are hinting thatgiven certain set ups,that could well be the case. The words “given certain set ups” have been emphasized because the technicals “are not quite there yet”. In the case of bond yields, I don’t think it would take much to tip the balance. If it is tipped, the only  questions on my mind would relate to the size of the rally, and whether it would be sufficient to reverse the secular downtrend in rates that started way back in September 1981. At this point I am just going to address the potential for a primary trend reversal, leaving the secular, or very long-term, views for a later article when more evidence is available.

Two charts that may soon look to the bullish side for rates

Chart 2 compares the 20-year Government Yield ($UST20Y) to its 12-month ROC. The arrows show periods when the 12-month ROC has crossed through or reversed from a position at or in excess of extreme levels. I have used the +20% and -20% levels. Following the yield forward from the arrow tips indicates that this approach has consistently signaled important reversals in  trend. Red arrows flag declines and green arrows flag rallies. The thicker arrows denote reversals from the +35% and -35% zones. Generally, these result in stronger signals.

July saw the indicator fall to that -35% level and the opening days of August a reversal from that point. Since this chart is based on month-end data we can’t use that final plot until data for the last trading day has been published.  However, early August action does indicate how close we might be to a positive crossover of that -20% line.

Chart 2

More on why that crossover is possible later, but now we need to move on to Chart 3. It compares the 10-year yield to a ratio between government 20-year and Moody’s Baa Corporate bond yields. When this ratio, or rather its KST, rises, it tells us that bond investors are downplaying credit risks. That’s because their preference turns to higher yielding and lower quality bonds. Falling momentum, on the other hand, telegraphs that their fears are mounting, as we see a so-called ‘rush to quality’. The point of the chart is to demonstrate that there is a relationship between the momentum of this credit spread and the trend of yields themselves. In general, when fears of credit defaults subside, that can only mean one thing. Investors are growing in confidence that the economy is in a recovery mode and that rates in general, are likely to rise.

The vertical lines on the chart show reversals in the KST of the ratio that have taken place at or below the horizontal green trendline. All instances, except 1976 were followed by a meaningful rally in rates. Fast forward to the current situation where we see a KST that has crossed its MA triggering a buy signal.

Chart 3

There is another way of looking at this and that’s through a similar ratio between the iBoxx High Yield ETF and the Barclays 20-year Trust, (HYG/TLT). This is just as good a way of examining trends in credit spreads but lacks the long-term history of the Government/Baa ratio. It seems to me that if this HYG/TLT relationship can take advantage of the current rally in the short-term KST by moving above its 200-day  MA at .63, and better still above the red trendline at .65, that could well signal a stronger reversal in the KST featured in Chart 3.

Chart 4

Short-term technicals

One series that continues to intrigue me is the 5-year government maturity ($FVX), shown in Chart 5. This one recently broke down from a 3-year trading range but is now attempting to crawl back above the lower part of that range. If it can, it will indicate that the downside break was a whipsaw. There is a good chance of that developing because the short-term KST is in a bullish mode. Note that the Special K has been in a downtrend for a couple of years and is not far off its bear trendline. A move above it would represent a strong signal that this indicator had reversed.

Chart 5

Chart 6 compares the Barclays 20-year Trust (TLT) to a price and volume oscillator. The vertical lines show when the volume oscillator, in the bottom window, reverses from a very extended reading. This usually signals some kind of a reversal in price as this action either reflects a buying or selling climax. Buying climaxes (red) are bearish because they reflect an exhaustion of buying power. Not all result in reversals, as you can see from the blue lines. Recently the TLT experienced a buying climax. This time the KST, in the center panel, quickly reversed direction to the downside, unlike two of the three failed (blue vertical line) signals. That action suggests that the buying climax will “work” this time, thereby resulting in lower prices (higher yields).

Chart 6

When we look at the 7-10-year ETF (IEF) and the 30-year bond price ($USB), both series can be seen to have completed upward sloping head and shoulders formations. That further suggests that near-term factors will continue to weigh on the downside for prices (upside for yields).

Chart 7

Chart 8

Watch those metals

Finally, bond yields thrive on a trend of higher commodity prices. Chart 9 indicates that the principal metal exchange traded products look as if they might all be in the process of completing bases. If that does prove to be the case, it would be another advance signal of a stronger economy and higher yields to come.

Chart 9

Good luck and good charting,
Martin J. 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.