Bonds at Resistance - 7th Time the Charm?

Bonds are at the cusp of a breakout to higher yields. This chart from StockTiming shows the 30-yr Treasury hitting the down-sloping resistance line for the 7th time in 17 years. With the end of QE, it seems poised to break above, and if it remains above, signals a major trend change - the end of the Bond Bull Market of the Great Moderation since 1982. 

We almost broke the trendline recently (Oct), but the market did a head fake away from it. We have now returned. 

The STU's wave count has the 30-yr in a wave 5 up to above 5%. This would break the trendline, but it would also complete the wave structure, leading to a drop back below. As mentioned, a break above a trendline confirms a change, unless it quickly falls back below. 

The WSJ has reported on a divergence on rates between Morgan Stanley and Goldman Sachs: 

• MS sees a rise of the 10-yr to 5.5%, which puts the 30 yr above 6%
• GS sees a 3.25% rate, which pulls the 30-yr near or even below 4%

The Sunday NYT chose the MS position, citing Bill Gross of PIMCO, which believes the thirty year bond bull market is over. If so, the impact on the economy could be rough, as mortgage rats could rise 25% to over 6%, and consumer credit costs may seriously erode household discretionary income (see chart).

David Rosenberg summarizes the argument in a recent Breakfast With Dave, and concludes that bond yields do not tend to rise with high deficits after a credit contraction; instead they rise from increased economic activity or inflationary fears. He points out the contradiction in the NYT's position: if they do rise, as the NYT suggests, "there will never be a sustained improvement in the pace of economic activity." His view comes down to his expectations of inflation vs deflation, and he is in the deflationist camp:

Fiscal deficits that are designed to cushion the blow from a credit contraction, especially among households, generate far different results. With credit contracting, rents deflating, the broad money supply measures now declining and unit labour costs dropping at a record rate, it hardly seems plausible that inflation is a risk at any time on the near- or intermediate-term forecasting horizon.

Paul McCulley of PIMCO hangs with their "New Normal" view of prolonged low rates. He sees real GDP settling down to 2-2.5%, and expects 10-yr rates to settle to 4-4.5%, somewhat above where they are now, but not much, and only after unemployment normalizes to 5%. That could take a while, hence his view of prolonged low rates by the Fed. His view can be summarized as "never fade the Fed." Of course, with a huge bond portfolio, the last thing PIMCO wants is a sharp raise in rates, devastating their holdings, hence they have been very vocal promoting their New Normal.  

The primary counter to Rosenberg is that the current deficits are unprecedented in size and stretch (ie. indefinitely forward). Even WWII had an end to it, and was financed by forced savings by the public due to deprivation as production was targeted to the war effort. Sure, Japan has extended their deficits for two decades, maintaining low rates, but they have benefited by huge savings domestically plus relatively strong capital markets globally. 

ZH did a deep dive into this topic, beginning with analyzing how the problem has been kept in check for the past two years: the Fed's QE plus lots of short-term Treasury borrowing has resulted in modest interest costs, with 40% of the Treasury holdings being let out at essentially no interest. With QE ending, they think it unrealistic that the blended borrowing rates will remain low. They present several scenarios, focusing on what percent interest becomes of Treasury receipts (ie taxes):

The most likely case would be a rise from 6% to 16%. If MS is correct in their 5.5% 10-yr rate, this grows to 25%. If inflation rockets out of control, possibly this climbs to a catastrophic 50%. Worse, if tax receipts continue to fall, this could go towards Japan levels of 100%, the point of no return. 

The ZH analysis basically says that the Fed cannot use inflation to get out of the mess we are in. (Paul Krugman would do himself and all of us well by doing the math for himself.) Of course, the Fed believes it has a way to tighten without unleashing the $1T reserves it created for banks into a hyperinflationary lending binge: raise the rates paid on the reserves to keep them in the Fed. 

It always amuses me how fundamental analysis can come up with scratch - sound positions both ways. Sure, the fundamentalists can take comfort in the contradictory TA assessments as well, but often they provide stronger warning signs. Here is a classic TA pattern to watch, a head & shoulders in the 30-yr:

 

If we break the trendline, we could see bonds drop below par (100) as the H&S setup suggests a drop below the neckline the distance of the head above. Rates would shoot above 6%. Confidence in the US would drop, and the Treasury auctions would become more difficult. 

A lot if technical indicators are hitting extremes. The STU tonight reports that the USD's recent drop signals trouble: either a much deeper drop ahead, or sideways for a while. A further drop tomorrow pretty well confirms a downtrend. Weakness in the USD is another warning sign of weakness in bonds to come. 

Comments

[Jack]

we're still in a deflation. that trend line is firm and intact. one more visit to the 3.5% area during the next wave down, then it rises in a genuine recovery.

[Michael]

The CBOE Equity Put/Call Ratio hit 0.32 today, very close to the 0.25 hit back in 1990 at the height of the blow off in the Transportation Index.

http://stockcharts.com/h-sc/ui?s=$cpce

Interesting.

[marketman]

Hochberg once again talking about extreme overbought levels in the Nasdaq RSI, not since 2000 . . . blah, blah, blah.

Meanwhile, he posts a chart with a count that shows a 5-wave move off the second (X), and then has P2 right where we are now. However, according to EWT and Hochberg's count, the market CANNOT top here. Yet, Hochberg continues to speak in dramatic bearish undertones highlighting sentiment examples that haven't been seen in a decade.

In my opinion, EWI also looks as "lost" as one can be on the precious metals . . . apparently trying to find the count that confirms their own long term thesis. As usual, they are unable to be OPEN to the possibility that gold could go back up to new highs!

And there is now even a section on the website that refers to Blaming "Market Manipulators" for Losses is a Huge Obstacle to Success . . . and that in order "To win, you must accept the fact that losses are part of the game."

http://www.elliottwave.com/affiliates/featured-commentary/blaming-market-manipulators.aspx

Wow.

[Erasmus B. Dragon]

Such garbage.

When the resistance line is drawn on rates (or prices) themselves, and not the P&F chart, we are nowhere close to breaking a resistance line.

Prechter counts bonds in a 5 wave. Prechter gave up counting long term interest rates because he was terribly wrong. Now he never counts more than a few months, and that's just for traders, and pretty risky if you believe it.

ZH analyzes "inflation rockets out of control" - right, with 18% under employment, entire countries about to go insolvent - right.

A head and shoulders chart covers 3 years, when major bond figures take decades to develop. Wow, lots of credibility in a 3 year count.

Weakness in the US$ is a sign of bond weakness. This statement is made after the US$ has several months of strengthening, and a couple days of weakness - like it did at several points in the up trend. A truly breathless comment.

Such incredible garbage.

[Michael]

FYI...

Hochberg is on CNBC tomorrow at 7 AM Eastern with Joe Kernan and Becky Quick. Will you be getting up at 4 AM for that one Yelnick?

I hope not.
:)

[Anon]

I looked at the long bond, long term a little while back. It appeared that the real break in the market, interest rates, and debt levels began in 1987. The long bond attempted to retest the H&S it broke from at that time in 1987 and was held back for some reason - probably intervention. Eventually we will tag that line again. Markets have a memory. Excesses are purged. Over-throws beget under-throws. Etc. Etc. The longer it takes the worse it will get based on the slope of that line.

[yelnick]

Michael, Hochberg senses a top is nigh. I will post on this tomorrow around 4am. (Yelnick never sleeps ...) Sure, I will watch it - that is why God invented Tivo.

[monk]

Nasdaq composite is at 78.6% retracement of the downmove.

[Mark]

I agree with Jack. One more down in equities and up in bond prices. During that time bears will chime in I told you so. But it won't be the massive 3rd wave EWT anticipates. Instead it will be the 2nd wave consisting of an ABC.
Good stuff Mr. Yelnick

We're still in a deflation. that trend line is firm and intact. One more visit to the 3.5% area during the next wave down, then it rises in a genuine recovery.
Posted by: Jack | Wednesday, April 14, 2010 at 04:24 PM

[joe]

Duncan, give up this is going to blow up in your face.

Market is heading higher.

"Michael, Hochberg senses a top is nigh" aka, another short squeeze

[Mike]

if we follow the nikkei buble 1989- present........nasdaq will make the top around may-june this year and start to going down with new low in 2013 :)

[Greg]

Waking up to follow the market makes sense but to wake up to listen to what’s his name…Hochberg whatever, to spin garbage is beyond any common sense. These guys discovered a gold mine called Elliot Wave “Theory” and they milk it to make a living. Charlatans maybe a strong word but they do nothing more than monetizing the naïve investors’ need for some kind of guidance. Unfortunately many people buy into this and make it their foundation and filter of following the markets. This explains why some guys get so defensive when one attacks the guru they follow. The theory became their hope to take money out of the market and any attack to it is an indirect attack to their hopes and aspirations. Sometimes it’s sad to watch otherwise intelligent sounding guys get so emotional and irrational when one questions their – and their guru’s - market calls. But in my view this is exactly what stops them from making money. The fact that they come in every morning with certain market expectations is exactly what stops them from making money. And they keep in the same loop and they go through the motions over and over and they keep cheating themselves because this stupid theory ended up being their ONLY hope to take money out of the market.

[joe]

And Yeves says what??

Look - that yield is so toppy here - It can't hold up for long.

Say it did - how many more foreclosures would it mean? If the federal reserve is indeed the FEDERAL RESERVE - they will never allow that.

No - that yield is going to come way down here.

Joe

[joe]

There are clearly two Joe's here.

[DG]

But in my view this is exactly what stops them from making money.

I think what stops people from making money is not doing their due diligence on a "guru" before deciding to make that person their market "guide". A good marketing pitch should pique a person's interest in a "guru", but it should just be the start of your investigation of the "guru's" actual capabilities, not the end of it.

Any "guru" who actually has a good track record will make the archive of that track record available in all its detail. A crappy track record will be swept under the rug.

[Mr. Panic]

TLT has already broken through its triple bottom going back several months and has since rallied back above the trendline (but had a sizeable down day today.) Seasonality for bonds in a midterm election year predict a severe drop into late June. (Bonds have bottomed in June last few years).

10 day average of ISEE hit 238 on Monday, higher than the level of October 11,2007 but an even higher reading around 245-248 was hit in July of 2007. There was a very low ISEE reading on Tuesday which will make it hard for the 10 day average to skyrocket unless there are continued readings in the 260s such as today. Put call premium ratio hit a yearly low on Tuesday; wouldn't be surprised to see another one today.

[David]

i have posted a new video update... all my cards are shown

http://www.tradeyourwayout.com/2010/04/spx-video-update-3-confused-amigos.html

[Greg]

DG, I expected that answer from you. I know that when one brings up the issue of gurus, in your head Neely is questioned and – it became a pattern – you are supposed to “correct” the injustice and establish the truth. I don’t know if the record that you bring up repeatedly about Neely is an actual (even non-fee) discretionary account or just a record based on his market calls but I know for sure that there is a BIG difference between the two. In any case tossing a coin and getting heads 5 times one after the other doesn’t mean you are not tossing a coin.
You are relentless at answering anything that relates to your favorite guru and I admire you for that. That said, even though you sound like a smart guy I wonder why on earth you have to have an answer for everything or why you give so high importance to always having the last word? Even if we assume all of us unfairly question a guru, why is it so highly important to you to “correct” – any of - us? In any case, I know you will follow up etc. but I doubt I’ll have the stamina to follow you on your back and forth. I recall the last time I had direct exchange with you was more than a month ago when the market appeared to start a serious correction and probably you where in the money on some position at that time and you called some of the bulls clowns etc. From the little I know about the markets, the guys who take money out of them are not so eager to validate their beliefs in conversations but instead their top priority is to find out where they might be wrong. If you really believe that Neely’s method enhanced with whatever modifications you did on your spreadsheet will work then nobody’s opinion really matters to you. I will know when it will be the time where it makes money for you: when suddenly DG gets quiet.

[Your Dad DG]

DG = Dumb Glenn

DG is the idiot son of Gleen Neely and the cousin of Glenn Loser Neely.

[DG]

I don’t know if the record that you bring up repeatedly about Neely is an actual (even non-fee) discretionary account or just a record based on his market calls but I know for sure that there is a BIG difference between the two. In any case tossing a coin and getting heads 5 times one after the other doesn’t mean you are not tossing a coin.

Greg, I've run the numbers and on the timeframe I advocate following Neely's calls (Weekly), the odds that he is just "tossing a coin" are very low. All I have are the probabilities, I don't have complete metaphysical certainty, but all of us, pro and con our favorite methods, are in the same situation.

I'm not sure what "discrepancy" there is between a record of trades Neely's recommended opening and closing at specific price points and an actual account. Yes, I suppose that it would be rare to find a person who had taken every trade at exactly the time and price Neely recommended it, but that's hardly his fault. For example, on Sep. 26, 2008, Neely recommended his Weekly subscribers go 50% (risk 1% of capital) short the ES at 1218.5 with an initial stop at 1271. On October 6, 2008, he recommended covering at 976 ES. So, on what you are saying, rather than give Neely "credit" for making a 242-point gain, I should what?

Even if we assume all of us unfairly question a guru, why is it so highly important to you to “correct” – any of - us?

Because I am a "set the record straight" kind of person.

From the little I know about the markets, the guys who take money out of them are not so eager to validate their beliefs in conversations but instead their top priority is to find out where they might be wrong.

OK, so how would I go about showing YOU that I'm trying to always figure out where I might be wrong? Saying that I don't do that on a constant basis is like saying you've got some kind of perfect information about my thought processes, isn't it? If I make a post during a period when the market is going my way and I am poking fun at those on the other side, that is simply part of the game. In the particular instance you cited, the January/early February decline, I was already going long on February 5th and was fully-questioning the bearish case by February 12th, so I'm not sure what I'm supposed to take away from your comment here.

In fact, here is what I posted on my blog on February 13th. I'd say this chart is indicative of a person trying to figure out if he's right or wrong:

http://yfrog.com/31spyhourlyfebruary3p

[Hockthefarm]

Great stuff Y. I have some homework here for sure. I will dump my pttrx today at the close.

You watch crude prices, look at supply and demand and you are left picking a bun.

Then you are told that markets set interest rates and you look out at the curve and you begin picking the other bun.

Not saying it is wrong, just saying I'm having a hard time connecting the dots. Thus the homework.

Hock

[yelnick]

Hock, I have to do a post on the commodities bubble echo. Markets drive long rates, but that doesn't mean they are rationale, except the market is so large they tend to move slowly (except in a crisis). Speculators have much higher influence over commodities, and we have seen how they can run up and down rapidly. Hence that side of the bun is often flopping around. Right now oil is up amidst broad suply and anemic usage. Fundamentals? Unlikely ...