Bond Yields May Not Be Headed Lower After All

• Money Market Yields Continue to Look Vulnerable
• The 5-Year Yield is in a Secular Uptrend
• Longer-Dated Maturities Overstretched on the Downside

Money Market Yields Continue to Look Vulnerable

Everybody and their dog thinks that short-term rates will be cut by the Fed later this month. Count me in with the groupthink, unless some really strong economic indicators come out between now and then, or we hear of an unexpected breakthrough with the China trade talks.  In this respect, Chart 1 shows that the 3-month LIBOR rate is comfortably below its 12-month MA and the KST is still moderately overbought. Steady as she goes on the downside here.

Chart 1

The 5-Year Yield is in a Secular Uptrend

It’s when we get to longer-dated securities where I start to question if yields are likely to move much lower. Let’s start with the 5-year series, as shown in Chart 2. The red and green lines approximate primary trend movements. The main thing to note here is that the series of declining peaks and troughs, which had been in force since at least the 1990s, was reversed in 2017. This happened at around the same time the yield was crossing back above its 96-month (8-year) MA. At the time, this signaled to me that the secular downtrend for the 5-year yield had reversed to an upward one. During that very long-term yield decline, it was primary bear markets that experienced greater magnitude and duration, whereas bull markets in yields were more truncated. Now, that characterization ought to be reversed, as bear markets should be more limited in scope - hence the probability that the recent decline may have run its course. One currently negative indicator is the long-term KST. Assuming that my conclusion of a secular reversal is correct, we may well see it bottom out at a higher level than it did when the during the course of the secular bear.

Chart 2

Chart 3 argues that this is likely to be the case. The chart shows the history going back to 1995, where you can see that most upside reversals from the oversold -40% line for the 52-week ROC have resulted in rallies. Those that did not have been tagged with the dashed arrows. There aren’t very many of those. Last week, the ROC bounced from that oversold reading again, but not yet strongly enough to conclude that it represents the eleventh buy signal in the last 25 years.

Chart 3

Two factors suggest that this action will become more decisive. Firstly, the yield itself has fallen to very significant support in the area of the extended green breakout trend line. That line turned back numerous rallies prior to the upside breakout. Now, it should reverse that strong resistance role as equally formidable support.

Second, Chart 4 tells us that the short-term KST is in a bullish mode and is by no means overextended. The RSI is in an overall downward trend, as it has been confined below its 2018-19 downtrend line. This could soon change, as the yield itself looks as if it is in the process of forming an inverse head-and-shoulders pattern. Until it breaks and holds decisively above the 1.9%, however, it’s still a potential and not an actual formation. If completed, though, it would certainly result in an RSI trend line break, thereby signifying that the yield rally had legs.

Chart 4

Longer-Dated Maturities Overstretched on the Downside

The 20-year yield is featured in Chart 5, along with its 52-week ROC. It shows a similar picture to that being painted by the 5-year maturity, as the ROC has fallen to its overstretched green horizontal trend line and started to bounce. The arrows show that reversals from the oversold and overbought lines have consistently signaled trend reversals for the yield in both directions. The bounce, like that for the 5-year yield, is insufficient to yet qualify a genuine reversal to the upside. That said, two factors suggest that it soon will.

Chart 5

Firstly, Chart 6, featuring the iShares 20+ Year Treasury Bond ETF (TLT), is sporting a bearish daily KST. That suggests lower prices and the completion of the small 2019 potential head-and-shoulders top. Such action would also involve a negative 50-day MA crossover.

Chart 6

The second reason for expecting bond prices to drop and yields to firm up can be seen from Chart 7, which compares the iShares 7-10-year Treasury Bond ETF (IEF) with my Bond Net New High indicator. This series monitors a universe of U.S. and international bond ETFs that are registering net new highs over a 40-day period. In order to limit whipsaw moves, the plotted series is a 40-day MA of the raw data. The red arrows show when it peaks from a position at or above the overbought line, while dashed ones reflect complete failures. In the last few weeks, we have seen three such reversals, indicating potential short-term vulnerability. Indeed, action over the last few months looks suspiciously like an incomplete head-and-shoulders top. It is also reminiscent of the top in the indicator that developed in 2017, which was followed by a meaningful decline. That kind of outcome is obviously pure speculation at this point. However, given the widespread bullish sentiment and overstretched price, such a possibility is not unrealistic.

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.