Will the Test of Last October's High for Bond Yields be Successful?

The 30-year yield reached its high point last October and has been rangebound since December. Chart 1 shows that it began to break out of that trading range in late July, but has yet to succeed in taking out the October high. The 14-day RSI is currently correcting from an overbought condition. Note this momentum indicator has failed to generate an oversold condition so far in 2023. Even last December's overstretched reading was quickly followed by a sharp bounce. Both momentum characteristics are a sign of a primary bull market.

That's not to say that the early August high will not turn out to be the second top in a double top formation, but the evidence at this point falls on the side of the bulls.

The question now is whether October high will be surpassed. To help answer, let's look at some of the indicators that move in sympathy with yields to see what they are saying.

Confidence Ratios

A major determinant of bond yields comes from market participants' estimate of future economic growth. If they believe there is a risk of economic weakness or even a recession, safe-but-low yielding treasuries are favored over riskier high-yield corporates. That connection is encapsulated in Chart 2, which compares the 10-year yield to the ratio between the Fidelity Capital and Income to that for the Vanguard Treasury Fund. A rising series reflects growing confidence. That's because traders downplay the risk of economic weakness, as they go for growth over safety.

Note how this relationship moves in sympathy with the 10-year yield itself. Recently, it touched a new bull market high, suggesting that further yield gains are likely. It's no guarantee of higher yields, but such an outcome is more likely than if the ratio was headed south.

The ratio between the SPDR Financial ETF and that for the iShares REIT (XLF/IYR) offers another useful confidence relationship, the theory being that, when the more economically-sensitive and risky Financials outperform the higher-yielding REITS, it again reflects a more optimistic view of the economic outlook, which also happens to be consistent with higher rates. Chart 3 shows that the ratio broke above multi-year resistance in October of last year and is now trying to move above the 2022-23 trading range. A positive KST suggests that it will succeed. Whilst such action would not guarantee a breakout by the 10-year yield, it would certainly increase the odds.

The same comment can be applied to Chart 4, featuring the Financial/Bond ratio (XLF/TLT), which is already at a new high. The very fact that the 50-day MA has started to pull away from its red 200-day counterpart is a sign that it is headed higher and could drag the yield with it.

Bond Yields and Inflation

Inflation-protected bonds outperform their nominal counterparts when bond market participants are anticipating an inflationary environment, and vice versa. As a result, the ratio between them can be used to confirm or deny breakouts in the 10-year yield. Chart 5 shows this relationship recently broke out from a 9-month base, in sympathy with the yield itself. So far, it remains below last October's peak, so we cannot say it is leading rates higher. However, positive KST action suggests that the rally is ongoing.

International Rates

Interest rates do not move in isolation, but are tied to the global financial system. In that respect, Chart 6 features the 10-year yield for the UK, Germany and Japan. All have reached marginal new post-October 2022 highs. The only exception is the series in the first window, i.e., that for the US. If foreign rates continue to build on their breakouts, it will be difficult for US bond yields not to follow suit.

Conclusion

It seems likely that bond yields are headed higher, but there are two caveats. First, as shown in Chart 7, long-term momentum is still extremely overextended. The counteracting argument is that the recent record reading in the 12-month ROC offers a sign of a strong, young, and vibrant secular bull market. Under that environment, normal overbought readings are nowhere near as potent as when they develop during the course of a secular bear, which was the case between 1981-2020. All primary bull trends come to an end at some point, but at the very beginning of a new secular trend, it's possible to stretch the elastic a little.

The second point is that sentiment regarding prices is currently very negative. That's bullish from a contrary aspect. Also, commitment of traders data reveals that hedgers are positioned for higher prices (lower yields). Hedgers tend to be correct at major turns. That said, there are many indicators poised to break to the upside. If they do, it will be wiser to believe them.

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.