Low Bond Yields May Not Be Around Much Longer

• Secular Trend for the 20-Year Yield
• Lower Down Curve Yields Are Already in a Secular Bull
• Short-Term Oscillators Ready for Some Upside Action?

The coronavirus has triggered concerns about the recovery, which in turn has resulted in a sharp setback for yields. Falling yields are bullish for housing starts, which, as discussed in an article published last week, are a positive forward-looking indicator for the overall economy. Provided the virus remains relatively contained, fears concerning it will actually prolong the recovery. However, I digress, as the point of this article is to indicate that, despite recent yield weakness, the overall technical picture remains consistent with a possible reversal in the secular trend. By "secular," I mean the very long-term trend in rates, which averages a couple of decades or so.

Secular Trend for the 20-Year Yield

The secular move I am specifically referring to is the one that began in September 1981, shown partly in Chart 1. This move enabled the 20-year yield to experience a series of declining primary trend peaks and troughs between then and 2016, a rather lengthy 35-year period. Since 2016, the yield has tried to take out that low on two occasions, but has not yet succeeded. By the same token, we can see that no signals of an upside reversal, such as a sustainable major trendline break or a series of rising peaks and troughs, has been given either. Consequently, price action for the 20-year yield leaves us in limbo.

Chart 1

When technicians try to identify any turning point, they look for divergences and other discrepancies that indicate things are no longer in gear, either on the upside or downside, since fewer and fewer components of a universe are participating. Unfortunately, that kind of analysis is not possible for secular trends in bonds, as the number of data points for these super long-term trends are limited. Moreover, data for individual maturities, outside of money market and 20-year yields, from which we could observe divergences are very limited and mostly non-existent.

One of the characteristics present at previous secular reversals has been the establishment of a price pattern or trading range. In that respect, the pink shading in Chart 2 indicates a head-and-shoulders top at the peak of the post 1940s secular uptrend in the 10-year yield. Today we see the potential for a trading range marking the low points. Note that the 10-year series first hit its bottom in 2012, four years ahead of the 20-year series. You can also see that the KST is bearish, but deeply oversold. That throws out the possibility of a reversal at any time. The solid arrows indicate that KST reversals have usually been followed by a worthwhile rally of primary trend importance. To confirm a secular reversal, though, would require an upside penetration of that 1984-2020 green secular down trendline.

Chart 2

The momentum indicator in Chart 3 looks as though it is in the process of going bullish for yields. It is calculated from a long-term KST of the ratio between inflation-sensitive and deflation-sensitive stocks (!PRII:!PRDI). When it is rising, it tells us that equity investors are betting on resource-based stocks over interest-sensitive ones. In other words, it's the stock market's way of voting for inflation or deflation. When the KST turns up, it earns a green arrow. In most instances they are solid, which means that such reversals resulted in a worthwhile rally in the yield. Right now, the KST is slightly bullish, which suggests higher yields and a successful test of the 2016 and 2019 bottoms.

Chart 3

Lower Down Curve Yields Are Already in a Secular Bull

Technical action at the long end of the curve is indecisive as far as the secular trend is concerned. However, this is not so for shorter-term maturities. Chart 4, for instance, shows that the 5-year yield experienced a reversal of its (red) declining peaks and troughs, shortly after its 2012 secular low. Since then, the green lines indicate that the primary trend zig-zag has been an upward one. The latest coronavirus-inspired drop has merely pushed it back to support to support in the form of the extended dashed green breakout trendline. The latest downward thrust has also pushed it slightly below the extended red up trendline, which is a negative factor as long as that's the case. Note that the KST is also oversold but still in a declining trend. During a primary trend, markets are usually hyper-sensitive to short-term oversold conditions. By the same token, secular uptrends are very sensitive to oversold primary trend indicators. If our assumption of a secular uptrend for the 5-year series is valid, the current overstretched KST should certainly generate a formidable yield rally in the period ahead.

Chart 4

Shortening the maturity even more to the 3-year yield, the technicals are very similar. First, there's the upward zig-zag by the yield. This time, though, the base is a reverse head-and-shoulders rather than the 5-year double bottom. In this instance, the yield is again at support, but here it's at the breakout level of the inverse head-and-shoulders.

Chart 5

Short-Term Oscillators Ready for Some Upside Action?

Charts 6 and 7 show recent action for the 5- and 10-year yields, respectively. Both are experiencing range-bound action, that could turn out to be a consolidation pattern as a prelude to further yield declines. Alternatively, these trading ranges could turn out to be a bottom. Given the oversold nature of the primary trend indicators and the positive short-term KST action, it seems likely that yields will bounce from here. That's not to say that we will see an upside secular reversal any time soon, but it does suggest that the bottoming process, following 30 years or so of declining rates, will extend. The two near-term upside benchmarks to look out for would be 1.5% for the 5-year and 1.7% for the 10-year.

Chart 6

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 Groupof Walnut Creek or its affiliates.