The Case For Rising Rates Is Starting To Fall In Place

The long-term picture

A couple of weeks ago I started to make the case for rising rates, based partly on the kind of price action featured in Chart 1. However, what was needed to reverse some of the longer term trends of falling yields and rising prices in the credit markets was some short-term trend-reversing action. Focusing on rates as opposed to prices, this would be a kind of reverse domino effect. This week we seem to be getting the type of price behavior I was looking for.  First a refresher in the form of Chart 1. This one compares the 20-year yield ($UST20Y) to its 52-week ROC. The green arrows show when this momentum indicator drops to or below the -25% zone and then bounces off or reverses through it. Usually, a trend of rising rates (falling bond prices) follows such action. The red arrows show sell signals that were triggered in the opposite way. There were two double signals around the turn of the century and in 2014. Counting them as one signal each, there were 13 instances altogether. Each one resulted in a valid early bird indication of a primary or intermediate trend reversal in the 20-year yield. This week’s rally in rates has sent the indicator marginally over that -25% level once again.

Chart 1

These primary trend reversals can also be appreciated from Chart 2, which compares the 30-year yield ($TYX) to its Special K indicator. The Special K triggers major buy and sell signals when it penetrates trendlines and this is confirmed by similar action by the price, Right now the yield is slightly below its (dashed) bear market trendline as is the Special K. Clearly, it would not take much to tip the balance in a bullish direction. In one way that has already happened because the yield has just experienced a sharp breakout from a 3-month base. Let’s dig into this nearer term picture in greater detail.

Chart 2

Short-term bond prices

Chart 3 shows that the Barclays 20-year Trust, the TLT, has now completed a triangle top. Note the sharp drop in the last two days followed that false break to the upside just above the upper trendline of the triangle. That’s typical action following a false move such as the one we have just seen. That could mean a quick move to the downside objective called for by the pattern to the $131 area. One thing to bear in mind is Friday’s downside gap. Usually, there is an attempt to close the gaps within a 2-3-week period, which means that prices may rally in an attempt to close the gap before they drop towards the objective. The KST looks oversold but actually, it’s just below the zero level leaving plenty of downside potential before it reaches an overstretched reading.

Chart 3

Chart 4 features the daily closing prices, where the TLT is currently resting on a key up trendline. Note that the next support level lies at that $131 breakout area, right around the indicated downside objective from that triangle formation in Chart 3.

Chart 4

The five-year maturity

The five-year maturity ($FVX) is an important one because it stands between shorter term Fed induced rates and longer-term more market-driven maturities. This series is showing tentative, but not conclusive signs of a reversal. That sign comes in the form of a penetration of the 2016 down trendline, but this is tempered to some extent by the fact that the KST is slightly bearish. The technical event that really stands out is last week’s three bar reversal, and the fact that it formed during a whipsaw break below the red up trendline.

Chart 5

Chart 6 shows the situation in a more focused way. The three bars are contained in the green rectangle. The pattern consists of two wide bars separated by a third. The wide ones initially indicate a dominance by sellers, as the price opens near the high and closes near the low. The second wide bar confirms that buyers are now more motivated because prices open near the low and close near the high. Thus by the end of the third bar buyers are very much in control. The small bar that separates them represents a day of balance in which neither side dominates. The blue rectangle emphasizes this balance because two openings and two closes are contained in a very narrow price band. When the third day experiences a rally with a close well above the balance area flagged by the rectangle, the pattern is completed. Normally three bar reversals of both the bullish and bearish type, develop after a rally or reaction. This one formed at the end of a trading range but is still important because it turned out to be a whipsaw or false break below the red up trendline.

Chart 6

Chart 7 shows the five-year maturity from a longer-term aspect. Here, we can see that the yield has started to break above the 2014-16 down trendline and is currently right at the neckline of a potential inverse head and shoulders. The KST in the bottom window has started to turn down, so that may delay any near-term attempt at a breakout. The most important trendline of all though, is that green one for the Special K. That’s because it is intersecting with the red signal line. Were that to be violated, in conjunction with one for the yield itself, that would strongly suggest that a major rally was in the wind.

Chart 7

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.