Bond Yields Reach A Critical Support Zone

• The longer-term picture argues for lower yields
• Deflationary forces gain the upper hand
• Bond yields at crucial short-term support
• UK Yields in a life or death struggle

The longer-term picture argues for lower yields

Earlier in the month I wrote an article pointing out that many bond yields had reached mega resistance, and that there were several reasons for expecting it to hold. In the intervening period the yields on some maturities have started to soften to the point that they are on the verge of an intermediate type breakdown. Consider the fact that some sentiment indicators are at a bearish extreme and hedgers, who are usually correct at turning points, currently have a record net long position. Now, things really begin to get interesting. It’s important to understand though, it is only when these hedgers begin to unwind their long positions that yields would be expected to drop. Nevertheless, that extreme number tells us that most uninformed participants are expecting higher yields going forward.

One of the indicators I used at the time was a 78-month ROC of the 20-year yield. The arrows on Chart 1 show periods when the ROC crosses decisively through its overbought and oversold zones on its way back to the equilibrium level.  Such action is typically followed by an important reversal in the yield. In the last few weeks that indicator has decisively dropped below its overbought zone.

Chart 1

Also, Chart 2 tells us that the long-term KST for the copper price has decisively reversed to the downside. Copper is used in many different sectors of the economy and this momentum weakness suggests a slowdown in the growth rate of the economy is likely. That usually means that bond yields will fall, as you can see from the arrows which flag previous KST copper peaks. Only the 1983 signal, indicated by the dashed line, could be called a failure.

Incidentally, if we do see lower yields, I am not expecting a drop to new secular lows, merely an extension of the trading range that has been forming in the last few years.

Chart 2

Deflationary forces gain the upper hand

The ultimate inflation/deflation ratio, that between commodities and bonds, is featured in Chart 3, where we can see that it has violated its 2017-18 up trend line and 200-day MA. This relationship has also completed a 2018 head and shoulders top. Finally, the Special K has just dropped marginally below its signal line and 2016-18 up trend line. You can read about the Special K here. All of this suggests that deflationary forces now have the upper hand, and that ought to translate into lower yields.

Chart 3

Bond yields at crucial short-term support

The critical nature of the current technical picture can be seen from Chart 4, which compares the 10-year yield ($TNX) to the ratio between the Fidelity Capital and Income and Vanguard Treasury mutual funds (FAGIX/VUSTX). The FAGIX has a substantial proportion of its portfolio invested in higher yielding corporate bonds, whilst the VUSTX, as its name implies, is focused solely on risk free treasuries. Generally speaking, when the ratio is rising it means investors are confident in the economy and are not concerned about credit defaults. If you compare the progress of the two series you will see that a rising ratio is generally associated with a trend of higher yields. Right now, this series is at a crucial support trend line and its 200-day MA. The two of them together provide a very strong level of support. Note also that the 10-year itself is right at the dashed 2016-18 up trend line and the neckline of a likely head and shoulders top.

Chart 4

The 30-year Yield is also at support, as we can see from Chart 5. To be fair, it has dropped slightly below the trend line and 200 MA, but I would much prefer to see a more decisive drop before concluding that a true break has transpired. It seems likely that it will happen because the short-term KST, in the bottom window, has gone bearish. That also implies that the Special K will soon violate its signal line and up trend line.

Chart 5

To some extent we may already have seen a breakout, but for that we have to turn to prices in the form of the Barclays 7-10-year Trust (IEF). This ETF has just completed a reverse head and shoulders pattern and remains comfortably above its 50- and 200-day MA’s. The breakout has been supported with a positive KST. Consequently, prices are likely to move higher. This chart certainly supports the idea that a move  to lower yields is likely.

UK Yields in a life or death struggle

Chart 6 shows that the UK 10-year yield is in a very tight battle. On the one hand it tried to form a reverse head and shoulders pattern between 2016 and mid-2017. It subsequently experienced a small breakout, which subsequently failed. Now the yield looks as though it is in the terminal phase of completing a 2017-18 head and shoulders top. That distribution formation has yet to be completed with a drop below the solid red horizontal line. However, the short-term KST is bearish and the Special K has dropped below its 2016-18 up trend line, all of which points to weaker levels. Having said that, as with the US, I am not expecting a move to new secular lows, rather an extension of the trading range that began in 2015.

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 of Walnut Creek or its affiliates.