Bonds at the Crossroad as Energy Breaks to the Upside

The Dilemma Between the Long and Short-Ends

Last March, I wrote an articleopining that, while the primary trend was positive, the idea of rising bond yields may have been become too popular for the time being. In the intervening 2 ½-months, yields at the long end have backed off a little, but the correction has essentially been a sideways one. I also stressed the point that there were really two distinct trends in play, the rising primary uptrend at the market-dominated long-end and the declining primary trend for money market and other short dated yields where the Fed is dominant. Chart 1 points this out, as the 30-year yield continues to trade well above its 12-month MA, whereas the 1-year treasury has remained in a downtrend well below its average. The question now is whether rates have consolidated enough and are ready to move higher or whether we are likely to see lower ones.

Interasset Relationship Argues for Lower Bond Prices

Chart 2 suggests that lower prices and higher yields is the more likely outcome. It compares the 30-year bond price, with the KST calculated from the ratio between the 30-year bond, and commodity prices (CRB Composite). It clearly demonstrates that bond prices abhor inflation. The red arrows approximate the KST peaks, when commodities start to outperform bonds. The solid arrows tell us when this action is followed by a meaningful decline, while the dashed ones note false negatives. Despite the three failed signals, this approach catches most of the major down moves. That's not bad, considering the whole period reflected in the chart experienced a strong secular bull market. Currently, the KST is in a bearish mode for bond prices and has reached the equilibrium point. In most, but certainly not all, instances, this momentum indicator bottoms well below zero. That suggests the bear market has further to run.

Fine Intermediate Technical Balance

Chart 3 shows the dilemma with the iShares 20+ Year Treasury Bond ETF (TLT). The upper panel suggests that the price is tracing out a bullish inverse head-and-shoulders, whereas the possibility of a head and shoulders top is offered in the lower panel.

Chart 4 suggests that, if an upside breakout is going to take place, it is more likely to happen sooner rather than later. That's because the daily KST has just triggered a buy signal. Note that the 9-day RSI is still behaving as if it is in a primary bear market. There has been a plethora of oversold readings in the last six months that have not generated much of a rally, yet no overbought conditions whatsoever have been registered. Both are a sign of a bear market. In that respect, the trickiest point would come on an upside breakout that generated an overbought condition. It would be of paramount importance that the breakout hold, because a hallmark of a bear market is a whipsaw upside breakout. If my assumption of a primary bear is incorrect and a new bull market began in March, it would be important to see the RSI trade well into its overbought blue zone and hold.

Chart 5 looks at the 20-year maturity from the aspect of yield. Here, we can see that it is caught between two converging trendlines. The first is a red up trendline joining last August's low, with a series of late 2020 rising minor lows. The second is a green resistance one connecting the late 2019 highs with the March 2021 top. The long-term KST in the bottom window is bullish, further underscoring the likelihood of a primary bull market (bear market for prices) but its short-term counterpart can't seem to make up its mind. The two benchmarks to monitor are 2.45% on the upside and 2% on the downside.

Yields at the Short-End

Money market yields and related maturities are unlikely to move until prodded by the Fed. However, the central bank is always reluctant to raise rates at this part of the cycle and usually takes its signal from market forces. Remember, the Fed is a lagging indicator. The good news is that it doesn't like to switch policy very often, so the first hike or cut in rates is usually a reliable confirmation that a new primary trend is underway.

One maturity that seems to bridge the gap between the bond and money markets is the 2-year Treasury note. It's compared in Chart 6 with the yield on the 6-month T. Bill. The arrows point up the fact that, most times the 2-year series leads the T. Bill. Consequently, if we are looking for a possible hike in money market rates, we should look for a bottoming in the Two-Year Note.

Chart 7 shows the weekly action, where the yield appears to be forming a base. The positive long- and intermediate-term KSTs argue for an upside resolution, whereas the negative short-term series suggests that it will come later rather than sooner. The benchmark to look for in this regard is a Friday close above .025. That wouldn't necessarily tell us that a Fed hike was going to happen right away, but it would indicate that market forces were more seriously pointing in that direction.

Energy Breaking Out

Chart 8 shows that the SPDR Energy ETF (XLE) and the DB Energy Fund (DBE) are on the verge of breaking out and therefore joining the US Oil Fund (USO) in the center window.

Leading the way are three stronger candidates in Chart 9, the iShares US Oil and Gas Exploration and Production ETF (IEO), the VanEck Vectors Unconventional Oil and Gas ETF (FRAK) and the First Trust Natural Gas ETF (FCG). Perhaps these breakouts will add to the inflationary pressure being currently paced on the bond market?

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.