Tag Archives: 10 yr treasury note

Bond Spreads Will Set Year’s Tone

Our theme continues, the Treasury Bond market spreads will set the tone for 2016. We wrote here at Equities.com on January 5th that, “US Bond Little Changed in Spite of Chaos.” The chaos has certainly continued with the S&P 500 off nearly 5% since then and China’s issues are anything but settled. It’s not very often that the workings of the global economy can be examined in real-time through the lens of a daily chart. We think the congestion in the U.S. interest rate markets is providing us with this rare opportunity as we speak and that its forecasting abilities could set the tone for the rest of the year.

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Ten Year Treasury Notes at Critical Juncture

The current interest rate scenario has been by far the loudest nothing I’ve heard since Greece was about to collapse. The confounding factors have sent us back through 45 years of Federal Open Market Committee (FOMC) decisions line by line. This was tedious, to the say the least, relevant at its best. Aside from FOMC data perusals and the hopeful nuggets of useful information, price and time appear to be doing their best to draw our attention back to where the rubber actually meets the road. That being said, we’ve reached a critical point in price and time that should yield big clues in the future direction of interest rates.

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Tidal Shift in the Bond Market

The recent spike in Treasury yields could very well be signaling a change in trend direction. We rarely try to pick tops or bottoms in major trending markets. It simply doesn’t pay. However, we’re seeing lots of corroborating evidence that this may signal a shift in the global macroeconomic outlook. Therefore, this is one of the rare times when a pull back within the interest rate sector may not be a buying opportunity. In fact, if this is the beginning of the Great Unwinding we need to focus on all of the evidence to obtain a complete picture view, all the way from the trading screens to the man on the street.

The trading screens always provide the first clues of market direction. It’s important to remember that prices and yields trade inversely to each other. Therefore, when the price of the security rises, the interest rate declines. The opposite is also true. This is why we can talk about all time high prices and record low yields in the same sentence. The 10-year Treasury Note is the global proxy for US interest rates.

The last leg of this rally began in late November of 2007. The employment situation was starting to deteriorate and interest rate adjustment was the primary tool the Federal Reserve used to pump life into a faltering economy – prior to the economic collapse. The Fed lowered rates by a quarter point in four out of the last five months of 2007. They lowered rates eight more times in 2008 and finally committed to a zero rate policy in February of 2010.

The combined inventive efforts at the Fed eventually drove the 10-year rate to an all time low just under 1.5% in the cash market and an all time low on the 10-year futures of 2.3%. This is where it starts to get interesting. The 10-year Note has been trading at a negative real return for over a year. This means the interest generated by the instrument’s yield would not keep pace with inflation’s erosion of principle. The recent sell off has pushed its nominal yield above 2% while inflation is expected to remain a hair under that mark. Thus, bringing our first, “normal” look at a yield curve in ages.

The high water mark set in early May was fueled in part by Japan’s concerted depreciation of the Yen. The markets were well prepared for this. The US has provided massive stimulus over the last five years. Europe has added their share over the last three years through Greece, Spain and now, Cyprus. The logical next step in a globally competitive devaluation race was obviously a form of Quantitative Easing by Japan. Commercial traders here in the US stocked up on 10year Notes, accumulating their largest long position since February of 2008. Their expectation was that we would continue pushing the zero bound interest rate plan.

This may very well be one of the rare times when the commercial traders are just plain wrong. Historically, they’ve been very good at forecasting rate direction. This time the largest trading group may have been faked out as a whole. Two important points bring this home. First of all, their buying did fuel a rally to new highs…by a hair. Secondly, the weekly chart is beginning to show an obvious reversal bar. Will this turn into an, “Everybody out of the pool,” moment? I doubt it. However, I do expect them to continue to offload recent purchases, which will build up resistance on any attempted rallies.

The other primary point to make is the effect of the rise in interest rates on the housing market and its effect on the anemic economic recovery 99% of us have participated in. The national average 30-year mortgage has climbed by nearly 25% over the last few weeks rising from 3.4% to 4.2% according to Bankrate.com. This will have a big impact on the housing market, which had just begun to clear some inventory. This will also affect mortgage refinancing just as the deadline for governmental forgiveness approaches. The result of the spike in interest rates has caused a decline in the broad S&P 500 of nearly 4%. Meanwhile, the homebuilders ETF (XHB) has declined by almost 10%. The homebuilders have been a primary driver of the broad market’s rally since 2012 gaining nearly 100% in two years.

Higher interest rates are the last thing any of the major economies can afford. Half a decade’s worth of rate cuts, Quantitative Easing and Operation Twist, etc. have created a coiled spring of leveraged money hunting for that last bit of yield. The major reversal bar in the 10-year futures coupled with a large, unprofitable, commercial trader’s position could leave them left holding the hot potato. At its worst, this spike in rates steers us towards stagflation. An environment with rising inflation and no growth characterizes this. How far it spills over into the markets is unsure. Please call with any questions as this may well mark the inflexion point of what has been THE dominant trend over the last five years.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.

Cutting Through the Rhetoric

There are times when the markets tell us more about what’s going on than the people on TV. I think this is one of those times. The recent rhetoric has been a political budget argument over nickels and dimes when we they need to be talking about hundreds and thousands. The political blame and spin game is being played at its highest level. The reality is that we are quickly approaching the end of the second round of quantitative easing. The government’s balance sheet reached a record level of $2.63 trillion as of April 7th. This is evidence that the fed has been putting their purchasing power to work. The $600 billion that was enacted to keep interest rates low, provide loans to new businesses and help the economy regain its footing after the financial meltdown of ’08 may be coming to an early end. The markets suggest that the Fed’s next meeting on April 26th could put a kink in the free flow of dollars coming to the market.

There are arguments on both sides of this fence from the insignificant periphery right down to the board of governors itself. The quantifiable portion of this argument is that the commercial traders clearly expect a slowdown in inflation and the economy in the near term. The consensus and conviction of the commercial traders’ positions can be seen in multiple markets; corn, oil, heating oil, copper, bonds, 10 year notes, S&P 500 and Dow Jones futures, etc. Their shift in positions can best be described as, “defensive.”

Copper is typically referred to as the, “economist” of the metals markets. Its use in building construction has always been a fair barometer of the economy’s growth and contraction. Commercial traders in copper from the commitment of traders report have shed nearly 40% of their positions since late February. The combination of China’s successive rate hikes and tightening lending practices paint a clear picture that their fully stocked warehouses are in no danger of depletion.

The crude oil market has seen consistent selling by commercial traders above $100 per barrel. Fear, due to the unrest in Northern Africa has been the primary driver of crude oil prices. This market has remained oblivious to the fact that the storage wells in Cushing, Oklahoma are bumping along near record levels. The price of gasoline has disconnected from the price of crude due to refining issues, not supply issues.

Interest rate futures have seen a flush of commercial buying. The 10 year Treasury Notes have seen commercial positions increase by more than 20% while the 30 year bonds have seen commercial traders increase their net position from 70, 000 contracts at the end of February to more than 120,000 contracts currently. Their buying of U.S. interest rate futures is part technical, and part predictive of a flight to safety driving down Treasury yields.

The flight to safety is predicted from commercial traders selling stock index futures. Commercial traders were buyers on the mid March stock market correction. However, their buying was light and their selling since has pushed their net momentum to negative levels. They may view the extended period of low volatility in the VIX index combined with testing the markets’ February highs as reasonable long liquidation levels or, low risk short selling opportunities.

This combination of moves is certainly bearish. I believe it is predicated by the theory that QE2 may be brought to an early end. If this is the case, the short term reaction would be a stronger U.S. Dollar. This would obviously be a short term negative for commodity markets in general like copper, oil, grains, cotton, etc. However, this would do nothing to alter the global change in demographics. There will be no fewer people to feed and this will not impact the growing global purchasing power that has fueled much of the commodity rally. Therefore, the macro trends will remain intact. This will simply force out many of the weaker hands that have been riding the coat tails of the rallies on the way up.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.