Subscribers to the Metal Augmentor service are very fortunate to have access to the technical expertise of Eidetic Research, a highly-respected institutional level technical service that is of a quality rarely if ever made available to the investing public. Recently Eidetic prepared a long term technical analysis of the US Bond Market. The basic thesis of this analysis is that the 2008 low marked the bottom of a 1981 – 2008 yield cycle and that the trajectory is set for a slow march higher toward a rough target of a 7.25% yield, something unthinkable to many of today's economic observers.
U.S. Treasury Bonds: "'Yield' or Die" [1]
During the twentieth century long-term U.S. treasury bond yields experienced 4 major cycles. As the century opened yields were just coming off of a secular bottom that occurred in the 1890s. The above monthly closing chart of the 30-year yield picks up just before the end of the first cycle (up) in August 1920 (vertical cyan line) when yields hit 7.22%. Following the chart across the page, we can see a cyclical low at 1.98% in July and October 1941, the prolonged 40-year cyclical advance to an October 1981 high at 14.68% and the ongoing down cycle to a December 2008 cycle low-to-date at 2.691%.
The following analysis will focus on technical factors, which suggest that the 2008 low marked the bottom of a 1981 - 2008 yield cycle. As is our fashion, we will follow our usual procedure of examining charts in a time perspective that narrows from the long- to the short-term: monthly, weekly and daily.
Typically, futures markets are denominated in a unit of exchange - dollars, reals, euros, etc. - and are analyzed in that context. Interest rate markets are a different animal in that debtors issue bonds based on the yield that they will have to pay. Once issued bonds are bought and sold based on price. Therefore, our analysis will include both yield and price charts. As you will see, although price and yield are inversely related, charts of the two are not necessarily mirror images. However, we think that taken in their entirety they are corroborative and build a powerful case in favor of the market being at a cyclical, and perhaps a secular, turning point.
Our last in depth look at the U.S. treasury bond market was written in February 2008 (Time to Bet Against the House, Technical Trends in Perspective 2-06-2008). At that time yields on the 30-year monthly chart above had leveled out following a 2003 low at 4.236% and were holding around 4.26% -- the upper blue dashed line that we considered to be the top of a potential support zone between it and the lower blue dashed line at 3.20%. As we noted then,
"... the United States government has had the best of all possible worlds since the 1981 cyclical peak in yields: for 27 years the U.S. Treasury ... has been able to borrow money at progressively lower rates to finance an ever increasing budget deficit. Since about mid-2007 because of various problems with the credit worthiness of mortgage-backed securities, institutions have plowed huge sums into safe haven U.S. government instruments. That herd behavior across the full spectrum from 30-day T-bills to 30-year bonds is irrespective of yield differentials. ... Those differentials suggest to us that broad market action is being motivated more by feelings of duress than by cool economic analysis. We often associate significant market turning points with financial duress and are alert in such an environment for what we consider capitulation behavior -- usually when a player, individual or institutional, appears forced by circumstances to act out of desperation against his best interests. Have we passed that point? Given the plethora of ongoing negative announcements by financial institutions and their partial sellouts to foreign investors, probably not. One more big negative earth shaker may be waiting in the wings ..."
As events transpired, the unfolding crisis provided reason for lower yields, which occurred across the board. In our opinion the plunge into the December 2008 closing low on the 30-year bond at 2.691% marked a classic "selling climax" (a "blow-off" or "buying climax" in bond prices). As we see it, that yield is the low in a 27-year (1981 - 2008) bear market in yields (bull market in bonds) at a level that hasn't been seen since 1954. Yields then rose throughout most of 2009 and started down again in 2010 because of deliberate interfering in the markets by the monetary authorities at the United States Federal Reserve System. That meddling exacerbated the downside movement in yields when the 2- and 5-year U.S. notes established secondary lows below their 2008 numbers in November 2010. However, it is notable that 10-year notes and the 30-year bond failed to follow the short end and held above their respective 2008 yield lows.
What could that discrepancy mean? Let's look at the weekly chart of the CBOE yield index chart below.
This weekly yield chart illustrates the climax plunge into the December 2008 low (shown boxed at point SC), the subsequent rally into a first half 2009 high (shown boxed at point AR) and the broad downward consolidation that appears to have concluded in August 2010 at boxed point T. Also shown are circled concurrent red arrows on the stochastic oscillator and beneath the August chart low. Notes on the left side of the chart describe 1) a weekly bottom reversal range that occurred at point T, 2) the reversal occurred only fractionally below a Fibonacci-related 61.8% retracement of the rally from point SC to point AR, and 3) The reversal action caused an upturn in the weekly stochastic oscillator at levels that are often associated with intermediate-term trend changes. All three of these points are classic telltales that we associate with prospective bottoms and subsequent changes in trend.
To further corroborate that viewpoint we offer the following personal anecdotal account that describes in advance the above chart-related developments. In June of this year, when the CBOE 30-year yield index was at about 4.10% and dropping back toward its 2008 low, in an e-mail to economics blogger Mike Shedlock [3] we offered a textbook example of how the bond market should behave:
The yield rally from the 2008 low is a typical technically reflexive move that has stalled at the prevailing downtrend line that defines the ... dominant down channel. If the market behaves in a technically "normal" fashion, yields should ease into the 3.793 - 3.492% area as the climax low is tested. Once the low is tested, and when the yield eventually comes up through (the) 5.066% level we will see the start of the next bear market in bond prices.
As events played out, the CBOE index traded to a low at 3.462% on August 25, 2010 and has since recovered to the 4.45% area where it traded in the latter part of the past week.
At this time we want to shift our attention to the treasury bond price charts, which are annotated with our Elliott wave interpretations. First up below is a monthly continuation chart of the CBT (now CME) treasury bond futures with an accompanying 14-period stochastic oscillator. This long-term chart dates from futures inception and it encompasses the entire cycle that began in 1981. First, in the interests of trying to maintain a sense of objectivity about a purely subjective analytic approach we want to acknowledge that the wave interpretation presented here differs from that of our 2008 analysis. In 2008 our working wave interpretation implied a maximum upside price limit to the ongoing sequence at 140-11 basis the nearby futures. The 2008 all-time futures high at 143-00 nullified our then working wave scenario. Thus we show our revised and current working scenario. Note that the sole revision in our interpretation is the relocation of circled point C-ii in time from January 2000 to that shown here in October 1994 (Note: our original 2008 interpretation can be found in the Editorial archives at gold-eagle.com).
As we noted in our 2008 analysis, the 1940 yield lows were the lowest since at least 1798 (refer to A History of Interest Rates, Homer and Sylla, 1991) and they represent a potential secular low. In that context, developments since 1981 can be viewed as being corrective and that is the interpretation shown on the above monthly price chart. Our wave interpretation identifies an "inverted flat" which consists of 3 major swings that are typically annotated A-B-C. By definition an inverted flat pattern's swings A and B have 3 subswings while swing C has 5 subswings. For our purposes we have labeled the A and B swings as A3 and B3, showing their subswings as a-b-c, and the C swing as C5 while showing its subswings as circled i-ii-iii-iv-v. At this time we conclude that the entire sequence is completed at the 2008 high and only a move above 143-00, basis the front month futures, would cause us to scrap this interpretation.
Before moving on to our next charts we have two non-wave related monthly chart observations. The first is about price action. Note the two small red arrows to the right of point C5 and at the illustrated up channel's rebound line. When prices reverted to the channel after their aborted 2008 exit thrust an initial upside attempt (left red arrow) was stopped cold at the rebound line. Again, at the recent August 2010 high after a much more subdued but sustained advance buyers were again rejected at the rebound line (right red arrow). If nothing else market action at the top of the channel has shown that the dominant channel forces are back in place. The second observation concerns intermediate- to long-term market momentum. As of November 30 the 14-period stochastic oscillator turned down. The turn came from the 76 area, basis the Slow %D value (blue line). In the past 30 years the indicator has typically peaked above 80 when an intermediate-term price high was being made so November's indicator downturn may not be predictive of pending sustained price weakness. However, as we have noted elsewhere, we consider the monthly stochastic to be less accurate as a trend timing tool and more indicative of the overall long-term trend momentum condition; when it is declining and weekly stochastic values are also declining, trend conditions generally favor the downside.
If the treasury bond market is indeed in the process of reversing its 29-year uptrend from the 1981 cyclical price low, then we would expect to see evidence of that reflected in the price structure that has followed the 2008 price high at 143-00, basis the nearby Chicago futures. In that context, if a non-corrective primary down trend is beginning to unfold, then the initial wave development down from that high should consist of 5 swings. We will shift focus to the daily continuation chart for interpretive purposes. Unfortunately, the amount of daily price data between the high and the current close exceeds the ability of our computer to display it graphically in its entirety. Thus we must present our current wave stance in a combination of 2 daily charts. To evaluate the initial leg down from the December 2008 all-time price high we focus first on the daily continuation chart #1 below.
LargerImageHere is how we see the December 2008 - June 2009 down leg. A move from 143-00 to 113-04 with the following relationships:
- wave 1 simple structure
- wave 2 simple structure that retraces 61.8% of wave 1
- wave 3 complex structure
- wave 4 complex structure that retraces 50% of waves 1 - 3
- wave 5 simple structure culminating in potential Wave I (annotated large circle).
Notable points are:
- wave structure alternates between simple and complex in down swings 1, 3, 5 and corrections 2, 4
- down swings 1, 3, and 5 become progressively larger implying gathering selling pressure as the move matured
- corrective swing 4 does not overlap the low of swing 1 thus implying an overall trending rather than corrective condition.
Price action after the June 2009 low, circled point I, served to correct the preceding decline. If potential Wave I is the first of a new down sequence then a correction of it should have 3 swings. Our wave interpretation of that is seen in continuation chart #2 below.
LargerImageWe interpret the overlapping gradual recovery from June to November 2009 as having 5 subswings (annotated i-ii-iii-iv-v), the total labeled A5 (note that although the high of the sequence occurred on subswing iii, 3 consecutive new high closes occurred at the top of subswing v). Price weakness from November 2009 through early April 2010 traced out another 3 subswings that we labeled a-b-c; the entire move is labeled B3. From the 5 subswing structure of swing A3 we expect the eventually completed upside move (A3, B3...) to have a third and final leg up and that it should consist of 5 subswings. From point B3, our wave interpretation features 4 subswings (annotated i - iv) to the subswing iv low on September 13. In our view, subswing v was truncated and terminated October 6 - below the subswing iii high. This view, as is labeled in blue, is considered a "failure" in wave theory and it is perfectly permissible. Generally, we are not advocates of "failure" interpretations because we believe that most market action falls in the realm of the norm rather than the abnormal. However, in this instance we have adopted this interpretation because the 10-year note market with a similar wave structure (as well as all of the other markets across the yield spectrum) did make a new high in its subswing v (refer to the inset CBT 10-Year Note chart for comparison).
To summarize the above two charts and their annotated wave interpretations plus to add one final piece of analysis that further corroborates the view that the 2008 - 2010 price pattern defines a probable long-term top in U.S. treasury bond prices, let's take a quick look at the weekly chart below.
LargerImageFrom the December 2008 price high at 143-00 our wave interpretation features Wave I, which is comprised of 5 subswings labeled 1-5 in blue and terminating at 113-04, and Wave II, which consists of 3 subswings labeled A-B-C in blue, having a high point at 136-31 but terminating at point C. The additional piece of analysis is the illustrated 78.6% retracement level of Wave I at 136-19. Over the years we have found, at least for our purposes of analysis, that the 78.6% retracement level of apparently completed price moves proves to be a reliable benchmark as regards the maximum retracement that a market will make without completely reversing a move. In other words, if prices move from point X to point Y they can retrace .786 of the distance of XY without reversing the whole move. In the case of the treasury bonds above, Wave I covered 29 and 28/32 points. By our methodology a 78.6% retracement of that, a rally of 23 and 15/32 points, could occur without jeopardizing or reversing Wave I. So, adding 29-28 to the terminal level of Wave I at 113-04 gives us 136-19 as a probable maximum high for Wave II. The actual high for the move was on August 25, 2010 at 136-31 which marked the high of a daily top reversal range while the actual high close (Globex) was on August 31 at 136-18. That the market was unable to trade successfully through the 78.6% level provides, in our mind, additional evidence that Wave II was indeed corrective. That, in traditional technical terms, signifies a failed test of the December 2008 high. If that scenario is correct then ongoing weakness from point C is the inception of what will be a major price downtrend in U.S. treasury bonds.
Considering that prospect and staying with the weekly chart for a bit longer, we can say that price action in the week just ended (December 10) gave further evidence that the market is verging on a sustained downtrend phase. Notice how the weekly range expanded as values violated their 40-week moving average (proxy for the popular 200-day moving average) at 126. In addition to that negative development, the market has probed below the October-November 2009 resistance area at 123-25 - 123-09 (seen at illustrated point A). The December 10 Globex close at 122-21, basis the nearby futures, suggests that anticipated support (i.e., previous resistance) is not operative, a condition typical of a down trending market. It's still early in the game using this chart to conclude that the trend is down but if the still rising long-term moving average starts to decline that would bolster the downtrend case.
We think that all of the above graphics and text support the argument that we are on the cusp of a major sea change in the U.S. debt markets. At this time, barring a price recovery and close above 133-00, basis the front month Chicago futures, or a 30-year yield close below 3.635%, basis the CBOE index, our expectation is for recent price weakness/yield strength to continue. If that is so, then our next objective is to determine where yields and bond prices are going, at least initially. For that exercise we need to return to our lead illustration - the 30-year yield monthly closing chart.
LargerImageThe first thing that attracts our eye is the 7.22% level, which was the high monthly close at the 1920 cycle high (red down arrow). When you follow that level across the chart (dashed magenta line) you can see its significance at lows that occurred in 1976 and in 1986 (red up arrows). Additionally, back and forth activity occurred on either side of that level in the mid-1990s. Given this eyeball analysis, we view the 7.22% area as having pivotal significance and expect prices to gravitate toward it in the next yield up cycle. When we placed a retracement tool (shown with dotted dark red lines) on the 1981 - 2008 decline we found that a Fibonacci-related 38.2% retracement of that move falls at 7.27%. Therefore, assuming that yields are nearing a reversal in trend, our initial intermediate- to long-term upside recovery zone is 7.22 - 7.27%; call it a 7.25% target. Using the CME Group's U.S. Treasury Futures Price to Yield Tables [4], we find that the implied yield of 7.2502% on a "Classic U.S. Treasury Bond Contract " equals a price of 86-29 basis the nearby Chicago futures. Finally, if the treasury bond price establishes a weekly close below its June 2009 low at 113-04 then the application of classic technical analytic principles will imply a downside price target at plus/minus 89-00. Therefore, all three of these factors suggest that, if a trending phase develops it will have carrying potential at least into the high-to-mid 80s.
We would like to conclude with some market related albeit non-technical remarks: We are a trading organization and we write primarily for those who trade from the perspective of a long-term position trader. It may be no big deal for a technical analyst to apply some basic methodology that identifies a price trend and to get aboard a market for a ride. However, to stay with a move, particularly as it matures into its later stages usually requires something that transcends a veneer of technical work - a basic understanding of what principle is motivating the market.
To many economic observers in the current environment, particularly those in the deflationist camp, a move in U.S. long-term interest rates to 7.25% is unthinkable - something that can't happen and won't happen. That attitude is fundamentally no different from that held by the majority of observers in 1999 who could see no upside price potential in a gold market that was trading around the lows of an 18-year down cycle.
To those observers we reply that there is more that determines interest rate levels than simple inflation or deflation. For example, the ongoing collusive unconstitutional behavior of the United States Treasury Department and the Federal Reserve System has not been checked by the U.S. Congress and we assume that it will continue until extreme circumstances cause it to stop. Therefore, "creative" interference by those institutions in the U.S. financial markets such as we have seen since 2007 will continue. As the socio-economic fallout from the catastrophic chain of events that were set in motion in 2007 spreads, the Treasury Department and the Fed will devise more financial "remedies" that will work only to the detriment of the capital markets.
For purposes of these comments, to paraphrase economist George Reisman, capital is the accumulated wealth that we own and use to earn profits or interest. As Reisman has observed, "...The amount of capital in an economic system determines its ability to produce goods and services and to employ labor, and also to purchase consumers' goods on credit. The greater the capital, the greater the ability to do all of these things; the less the capital, the less the ability to do any of these things." [5]
The latest creative interference by the Federal Reserve, so-called quantitative easing, is nothing more than a monetization of the federal debt. The ultimate outcome of that monetization and other schemes yet to be hatched will be a destruction of the capital base of the U.S. That will occur regardless of whether the broad economic backdrop features inflation or deflation. The destruction of the nation's capital will eventually be reflected in treasury bond prices. The market will ultimately reprice those bonds that exist and those yet to be issued to reflect the reduced ability of the general economy to service its debt. Treasury bond yields will inexorably rise. Bonds will "yield" or they will die.
[1] King Henry IV - Part 1, W. Shakespeare
[2] Data sources: Knight-Ridder; CSI Data
[3] Mish's blog -- http://globaleconomicanalysis.blogspot.com/
[4] CME Treasury bond conversion -- http://www.cmegroup.com/trading/interest-rates/us-treasury-futures-price-to-yield-tables.html
[5] George Reisman's blog -- http://georgereismansblog.blogspot.com/
Charts constructed with Omega Research SuperCharts
Data Sources: Knight-Ridder (CRB); CSI Data; Reuters DataLink
