Long-Term Interest Rates Getting Close to an Upside Breakout
The Fed has pledged to keep short-term rates around zero for an extended period. That's certainly in their power, and Chart 1, which features the 3-month Libor, indicates no sign of life. There is also quite a distance between the latest plot and its 12-month MA. At this point, a bet on higher short-term rates in the immediate future does not seem that wise.
Further down the maturity spectrum, things are slightly different. Chart 2 compares the yield on four international 10-year bonds. All are confined below some kind of resistance, especially the non-US series. The down trendlines for the German and Japanese series are particularly lengthy and have been touched or approached on numerous occasions. That makes them highly significant barriers. The US 10-year yield fell the sharpest in the 2019-2020 period and is now recovering at a faster rate than the European or Japanese series. It too is facing resistance at a 2-year down trendline.
Chart 3 shows the end of the post WWI secular bull market and the post 1981 secular bear. It offers a classic example of a counter-secular trendline breakout that took place in 2018. Such false moves are typically followed by an above-average price swing, as market participants scramble to get back to the right side of the market. That certainly was the case in 2019 and 2020.
Recently, the chart has taken on a more bullish tone, as the yield has crossed decisively above its 12-month MA. Also arguing for higher rates is the long-term KST, which has just turned bullish. The solid green arrows indicate that these kinds of reversals usually indicate that higher rates are coming. The 1972 and 1978 signals were particularly strong ones, but that is because the secular or very long-term trend was positive at the time. All the other signals, including the weak 1990, 1997 and 2011 ones, were swimming uphill in the face of downside pressure from the secular bear.
We do not know how the most recent KST buy signal will perform, but, with interest rate levels still not far from zero, it seems likely that the current rally could represent the opening salvo of an extended trading range, the completion of which would signal a reversal in the secular downtrend. This would be the opposite of the secular top that formed in the late 1970s and early 1980s.
One hint in that direction comes from the extremely volatile action of the 12-day ROC (Chart 4), as it touched a record reading coming off the March 2020 low. That's what we call a "mega overbought," as it surpasses anything seen in the previous bull or bear market. It's momentum's way of heralding a basic change in psychology. Mega overboughts are similar in concept to a breadth thrust, but, in this case, are reflective of price. To me, it is one piece of evidence that the secular downtrend is in the process of being reversed. It could be argued that this unprecedented bounce was due to the extremely low prevailing level of interest rates and, therefore, a mathematical aberration. However, the world in which we live, where some countries have slightly negative rates and the US is close to zero, defies 5,000 years of interest rate history and is an aberration in and of itself.
Returning to the current rally, the center panel in Chart 5 displays the ratio between inflation-protected and nominal bonds. This relationship helps us discover whether bond market participants are anticipating inflation or deflation. If they fear the former, that's reflected with a rising ratio, and vice versa. These movements also track swings in the 10-year yield. The green and red arrows approximate KST peaks and troughs in the ratio. Solid arrows indicate valid signals; dashed ones indicate a non-existent or very weak trend reversal. This momentum indicator has turned up again and the ratio itself has violated its 2019-2021 bear market trendline. It has also rallied above its 12-month MA. All of that, given the close relationship between the yield and ratio, suggests that the yield will also be able to clear its bear market trendline.
That view may be tested in the next few weeks, as the price is not far from support at 9.50, in the form of the green extended breakout trendline, the red up trendline and the blue 50-day MA. It all depends on how the yield deals with an overbought and declining daily KST. The September and November peaks were both followed by sideways consolidations, which is a bull market characteristic and consistent with the KST buy signal in Chart 3. On the other hand, a drop below that support would probably mean that a more durable correction is in the wind and any major upside breakout is put on hold.
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.
