Chart Of The Day: Another Plunge In Treasury Yields Could Be Just Ahead

Chart Of The Day: Another Plunge In Treasury Yields Could Be Just Ahead

Pinchas Cohen/Investing.com  | Aug 13, 2019 10:19

If plunging yields rattled markets till now, hold on to your hat. The trading pattern on the benchmark 10-year Treasury note as well as intermarket analysis suggest there's another leg down ahead.

In a healthy market, where one can expect advances to be sustainable, traders invest in stocks when they see companies growing profits. All things being equal, this tends to happen in an expanding economy. Investors hoard bonds when the economy is slowing and the outlook for rates is lower.

How then, can stocks continue notching all-time highs even as investors continue driving Treasury yields to multi-year lows?

Some say this time is different. Perhaps the causal link between stocks and bonds is broken.

Maybe. In a negative yield environment in which Denmark offers a 20-year mortgage for a zero interest rate, it's possible U.S. yields—which remain low albeit positive—are a godsend.

Conceivably there is no argument between stock and bond investors. Both are increasing demand on the outlook of a slowing economy, but for different reasons. Bond investors are buying Treasurys now, before they fall further, ahead of anticipated additional rate cuts. Stock traders, on the other hand, are increasing equity demand on speculation the Fed will keep feeding the monster...with lower rates.

Of course, there have been quite a few short periods when stocks and bonds have moved in unison before this, such as during the heyday of the Trump Trade. Ultimately, however, the market cannot function when investors are pulling it in two different directions.

For now, bonds are beating equities. And historically, bonds tend to get it right since retail investors generally buy only stocks but institutions also invest in bonds. With that in mind, the first stage of an equity market top can often be detected when the smart money hands off overpriced stocks to unsuspecting amateur investors.

Though the supply and demand picture isn’t clear, signs of a setup for another leg down for yields could likely send equities into a sharper selloff.

10-Y UST Daily

10-Y UST Daily

The 10-Y yield fell yesterday, breaking out of a four-day congestion. Trading tilted upward within the range as does a rising flag within a downturn. Our only reservation with this interpretation is that the rule of thumb for a flag is a minimum of five sessions. This one lasted four before the breakout.

However, the 20% crash in just a week, followed by the range dominated by an upward bias—telltale signs of a rising flag—amid a repeated inverted yield curve, make us sufficiently confident in this interpretation.

The flag pole's initial plunge occurs on the panicked selling of an asset (or in this case, the buying of Treasurys, pushes yields down). The consolidation takes place when the market catches a breather and takes the time to evaluate whether this activity might have been a knee-jerk move.

The upward bias of the range demonstrates that demand for the asset is gaining on the supply; but the downside breakout reveals that, in fact, supply absorbed all demand and became even more panicked as offers were lowered to find a new batch of willing buyers.

Whether the pattern is a bonafide rising flag or not, last Wednesday’s hammer is a presumed support, and Treasury buyers are still likely licking their wounds after the very long lower shadow of yields sucked them in before bouncing right back.

At any rate, if yields fall below 1.595, the hammer low, the probability increases for another 400-basis point plunge, repeating the prior move, the flag pole. This scenario matches the developing bearish flags for U.S. indices, whose downside breakouts would add to the weight of the evidence of a long term top since January 2018, discussed here.

Pinchas Cohen/Investing.com

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