From the Desk of Ian Culley @Ianculley
The strong US dollar and higher interest rates have dominated the conversation this year.
But the direction of the US Dollar Index $DXY has changed, breaking its year-to-date trendline earlier this month.
Will interest rates follow?
Not yet! So far, the uptrend remains intact for the five-, 10-, and 30-year yields. We have to give these trends the benefit of the doubt, for now.
Despite their persistence, it seems more a matter of when not if rates do eventually roll over.
Based on information from the US bond market and developed-market European yields, it could happen sooner than you might expect.
Let’s break it down.
First, we can’t dismiss the middle-long end of the curve holding above year-to-date trendlines.
Our outlook remains higher for these yields as long as their trend lines hold. If they do begin to break down, we’re monitoring the June pivot highs for confirmation.
Since the rising rate environment has been a global phenomenon, we’re also tracking European yields for confirming evidence.
European benchmark rates have served us well this year, providing insight into the direction of US yields on multiple occasions.
Check out the 10-year yields on German, French, and Spanish government bonds retesting their June pivot highs:
The signals vary from finding support to undercutting key pivot lows. But, as of Thursday morning’s session, Germany's and France's rates are decreasing in unison with Spain's.
These breakdowns imply US rates are next. Before we get ahead of ourselves, we need to witness downside follow-through from international yields.
It’s not just European interest rates, though. The US bond market also suggests lower treasury yields in the near future.
In mid-October, the message regarding bonds was "don’t catch falling knives."
The downtrend remained in full effect with no signs of relenting. We had no business buying bonds until they provided a tradeable low to define our risk. Simple!
Almost two months later, bonds are doing just that: carving out tradeable lows.
The five-, 10-, and 30-year Treasury futures look identical. And all three carry the same implications for rates. As bond prices rise, their associated interest rates fall.
Let’s run through some key levels.
Here’s the five-year Treasury note breaking out of a multi-month base:
We like taking a swing at the five-year if and only if it’s above 108’11, targeting 114’07.
It’s a similar picture for the 10-year T-note:
The 10-year is completing a multi-month base, taking out its October pivot highs. As long as it’s above 113’11, we’re long toward 121.
Unlike the five- and 10-year notes, the 30-year T-bond hasn’t broken out yet.
If and when it prints a decisive close above 128’15, we’re buyers on strength with an upside target of 143. The 30-year T-bond is off limits until then.
When the data changes, you have to change with it. Buying bonds at these levels requires a certain degree of flexibility.
It also carries an inherent bias toward falling rates. Add a weakening dollar and declining European yields to the mix, and the evidence points to lower US interest rates.
Also, long-duration assets are experiencing relief from selling pressure, including growth stocks. These areas should continue to receive a boost if rates resolve lower.
Regardless of the data suggesting a decline in yields, the uptrend persists.
If and when the five-, 10-, and 30-year start to roll over, pay attention to those June pivot highs for confirmation. A break below those former highs represents downside risk and leads to the next question…
Will a decline in rates foster sustained relief or a simple reprieve from the rising rate environment?
Stay tuned!
Countdown to FOMC
Following the release of the Federal Open Market Committee minutes and Federal Reserve Chair Jerome Powell's most recent remarks, the market is pricing in a double-hike in December, followed by a single-hike in February and March.
Here are the target rate probabilities based on fed funds futures:
Click the table to enlarge the view.
This data is from the CME FedWatch Tool as of November 30, 2022.
Thanks for reading. And please let us know what you think.
As always, be sure to download this week’s Bond Report!
