Heading into Q3, we wanted to play a mean-reversion bounce in US treasury bonds. A long list of reasons supported this position:
US Treasuries experienced their worst H1 in history (or close to it).
Bonds were finding support at their previous-cycle lows from 2018.
Commodities and inflation expectations peaked earlier in the spring.
Assets that benefit from rising rates (financials) were making fresh lows.
Global yields were pulling back.
And, quite frankly, our risk was well-defined. We can’t ask for much more. For us, the greater risk was not taking a swing at this trade in the event bonds ripped higher…
Two months later, bonds across the curve are taking out their 2018 lows. The market has proven our mean-reversion thesis wrong. But we can live that because we manage risk responsibly.
It’s the most important part of playing this game.
Easily, the second-most important is to remain flexible.
Identifying trends is one of the most important jobs of a market technician. Regardless of our time horizon, we have to understand the general direction the market is taking.
It sounds simple, but it’s the foundation of any market thesis.
Once we have the underlying trend nailed down, we can focus on the areas of the market we want to exploit and pinpoint the best tools and strategies to do so.
When I think of the most critical trends to date, my mind immediately goes to interest rates. Rising rates and inflation have been the key drivers for two years now.
Despite some corrective action in recent months, the bond market has been reminding us that we’re still in a rising-rate environment.
Let’s take a look.
First, we have an overlay chart of the US 10-year breakeven inflation rate and the US 10-year yield:
The market environment has been shifting in favor of the bulls all summer.
Breadth thrusts are firing as participation beneath the surface expands. Risk assets – commodities and stocks alike – are reclaiming critical levels of former support.
This is a huge departure from earlier in the year.
But one aspect of the environment remains the same – interest rates. Yes, rates have come off their June peak. And, yes, US yields have paused at a logical level marked by a series of former highs.
That’s all true, and it all makes perfect sense.
But we still find ourselves in a rising-rate market as the underlying uptrend remains intact – for now.
Earlier in the month, we broke down the ranges in the 30-, 10-, and 5-year US yields. Today, we'll turn our attention overseas.
From the Desk of Steven Strazza @Sstrazza and Ian Culley @Ianculley
It’s been an action-packed year for the bond market. Rates have ripped, and bonds have been in free fall worldwide. But US yields stopped going up in June.
More recently, many European benchmark rates have turned lower in dramatic fashion.
Now the question is whether US yields will roll over and follow to the downside.
Instead of getting caught up in the Fed chatter and all its implications, let’s focus on the key levels we’re using as a roadmap for treasury markets in the coming weeks and months.
Here’s a triple-pane chart of the US 30-, 10-, and five-year yields:
All three are carving out potential tops just beneath their respective 2018 highs. You can see the tops in the chart above.
And those critical 2018 highs are highlighted below:
It’s the day after the FOMC announcement, and markets are mixed. They’ve already moved past yesterday’s 75-basis-point hike and are now in the process of pricing in all available data, including the prospects of future Fed policy.
Instead of getting caught up in the recession chatter and what the Fed might do next, let’s focus on one undeniable fact: The 10-year US Treasury yield $TNX is still at a key inflection point.
I know we’ve been obnoxious about the US dollar and rates. They continue to be two of the most important charts out there. That’s the environment we’re in – plain and simple.
And with the 10-year yield stuck just below a critical shelf of former highs, there’s no better time to remind ourselves of some classic intermarket relationships.
Here’s a chart of the US 10-year yield overlaid with the Metals and Mining ETF $XME with the ARK Innovation ETF $ARKK in the lower pane:
These ratios typically trend in the same direction as interest rates. But this hasn't been the case since last year.
And when we consider that yields are trapped below major resistance zones, we really like the counter-trend opportunity bonds are offering at these levels.
Let’s review a few setups from our Q3 Playbook we like for buying a bounce in bonds.
