Interest Rates Are Still Heading Lower

One of my favorite themes coming into the new year was how the market would react to lower interest rates. I couldn't think of a single person who didn't "know" that rates were heading higher. It was just assumed that we were in a higher interest rate environment. Extremes like this in sentiment make the best trades.

Now that we're in February and interest rates have gotten crushed as bonds exploded higher, we hear and read about how unexpected this was. This is the common reaction to an unwind in extreme sentiment. Readers here know we were all over this trade (see A B C & D) but there seems to still be more coming. I really don't think this drop in rates is over.

These unwinds in sentiment can last longer and take prices further than most expect. In fact, I often see these unwinds ignore what would traditionally serve as reliable support and resistance levels. Sentiment can be that powerful when the masses are on completely the wrong side of the trade, which is precisely what we had here.

But let's put that aside for a minute. Price, at the end of the day is the only thing that pays us. Extreme sentiment unwind or not, price still rules in our world. So here is the weekly chart that we were first pointing to when we caught the bond bears napping.

Every time rates get up to this down trend line they seem to roll over pretty hard. In fact, every time rates have hit this level, on average they get cut in half. I'm not predicting that this will absolutely occur once again, but a 10yr yield back down to 1.5% would be perfectly normal.

Also notice the bearish divergence in momentum at the December highs in rates. That could be another catalyst to send yields much lower.

Now, taking a closer look at interest rates, here is the same daily chart we were looking at back in December. We have a clear false breakout in the 10-year yield that failed to hold above the September highs and key 3% psychological number. Also, while prices were failing up there, momentum was already rolling over confirming the same bearish divergence we see in the weekly chart:

It seems to me like this 2.5% level in yields better hold. Otherwise, there is a long way down to go just get a normal correction in yields, which is near 1.5%. And from my experience when we see a false move, the fast move that develops in the opposite direction can travel much further than most expect. Like in extreme sentiment unwinds, I often see traditional support/resistance levels completely ignored in these cases. So we cannot assume rates will just turn around and start to rise. Sure, will we see a bounce? Of course, but for right now I think any short-term rise in yields will fail quickly.

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Tags: $TLT $TNX $ZB_F $ZN_F