After Federal Reserve Chair Jerome Powell’s remarks this morning, the market is pricing in an 86% chance of a 75-basis-point hike later this month.
Meanwhile, rates continue to accelerate at the short end of the curve. That’s been the story for months now.
But will the middle and long end of the curve head higher as well?
According to the two-year US Treasury yield, the answer is a resounding "yes!"
Short-duration rates offer plenty of valuable, leading information regarding US Treasury yields.
We’ve leaned on the five-year yield throughout the current cycle as an early indication of the direction of the 10- and 30-year. It’s proved a beneficial practice.
Today, we’re going to drop it down a notch, extending the same logic to the two-year yield.
Here’s a quad-pane chart of the two-, five-, 10-, and 30-year US Treasury yields:
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.
No one likes a bear market, except for the bears of course.
They haze the uninitiated, test market veterans, and remind everyone that assets can go to zero.
Not fun for most!
When we take a step back and assess all the data in front of us today, the outlook remains dismal for the overall market.
The New York Stock Exchange and the Nasdaq have posted more new lows than new highs for 31 weeks and counting. Leadership groups carry a defensive tone. Topping patterns continue to resolve lower. Support levels are being ignored and violated. Long story short, it's ugly out here.
And it's not only stocks... Bitcoin just booked its worst month and quarter in over a decade and bonds are having one of their worst years in history.
No wonder investor sentiment is in the dumps. It’s clear we are in the midst of a bear market.
They’ve replaced the comical “stocks only go up” memes with images of the grim reaper coming for our favorite names. Even memes aren’t as funny in a bear market!
From the desk of Steven Strazza @Sstrazza and Ian Culley @Ianculley
Bonds are off to their worst start in the past 40 years, possibly ever!
It’s not even close.
As we near the end of Q2, the US Treasury Bond ETF $TLT is down almost 22% year to date. And that’s after its recent bounce higher.
There's been nowhere to hide, as these traditional safe-haven assets have been an absolute dumpster fire along with stocks.
But we’re starting to see some of those flames extinguished.
Some of the worst-performing stocks tipped the bond market’s hand ahead of the recent lows. That’s right: Those Big Tech names and Chinese internet stocks stopped going down months ago and now bonds are following higher.
Believe it or not, bonds and high-duration equities have a lot in common. The Growth $IWF versus Value $IWD ratio really tells the story.
Let’s take a look.
Here’s an overlay chart of the TLT and the IWF/IWD ratio:
And don’t worry: Plenty of banter surrounding the yield curve will take center stage during all this recession talk.
Somehow, an inverted yield curve has become synonymous with recession even though the historical record supporting this narrative leaves room for plenty of interpretation.
The purpose of this post is not to present an argument on whether we’re already in a recession or if one is imminent. We’ll leave that up to the talking heads and economists.
Instead, we'll simply share where the yield curve is today and assess the likelihood of potential inversion.
Let’s take a look…
Here’s a triple-pane chart of the US 30-year, 10-year, and 5-year yields:
From the desk of Steven Strazza @Sstrazza and Ian Culley @Ianculley
The Japanese yen continues to be front and center, as the safe-haven currency can't seem to find its footing.
In a market where risk assets are struggling to catch any sort of sustained bid, finding investment opportunities in yen has been a great strategy. It continues to work.
Aside from providing a stellar trading opportunity, the current intermarket relationship between this forex cross and the bond market may reveal the near-term direction of the US 10-year yield.
Let’s take a look.
Here’s an overlay chart of the USD/JPY pair and the US 10-year yield with a 26-day correlation study in the lower pane: