On May 16th, with the 10-Year Treasury yield trading as low as 2.49 (at least, as proxied by the CBOE 10-Year Treasury Interest Rate Index, $TNX), I predicted that rates would fall farther still. I cited as evidence for my view a declining short-term momentum cycle and an Elliott Wave Theory-based interpretation of price action that called for lower lows. My mid-May report referenced first support between 2.41-2.47, and 2.35 as a potential secondary stopping zone. The following chart was featured in that note and appears below in its original, unaltered form.
I suggested in last month’s missive that the clock was ticking for the decline in yields, as, while still likely to fall for days more, a bottom in short-term momentum looked to be on the horizon. I confessed though a lack of confidence that a coming low would be anything more than a pause in the bigger picture decline, as medium-term momentum looked like it might continue to worsen deeper into summer. That note from a few weeks ago can be accessed here.
Hindsight tells us that yields did slide lower after I penned the aforementioned analysis. In fact, the intra-day low for $TNX, at 2.40%, was registered on May 29th. My short-term oscillator bottomed one day later. In the four days since the standing YTD low for yields was recorded, $TNX has run-up by 20 bps. This move was sufficient to force a bottom in my medium-term momentum series. Thus, momentum is now constructive for 10-Year Treasury Yields at both short and medium degrees. As such, it appears highly probable that 2.40% marks an intermediate-degree low for yields, and that $TNX will continue to advance into at least August. The chart below graphically depicts the short and intermediate-term momentum condition for the 10-Year Treasury Yield.
This development is material even to equity-only investors, as the direction of rates movements has decided implications for stock market leadership. To wit, the chart below shows $TNX in the top pane and the return of the Russell 3000 Dynamic Index minus the return of the Russell 3000 Defensive Index (a measure of the relative performance of cyclical versus defensive equities) in the lower pane. Notice that both series tend in the same direction. This is to say that cyclical equities tend to outperform in rising interest rate environments and underperform when rates are falling. So, an end to the slide in rates might reasonably be expected to coincide with an end of leadership by defensive sectors (this top-down conclusion jibes with (bottom-up) sector-level momentum work which currently identifies Information Technology, Consumer Discretionary and Industrials as sectors with compelling medium-term prospects). Thus, equity investors should consider accentuating these more economically-sensitive areas of the stock market for the next several months.
In summary, after my mid-month call for rates to move lower $TNX did continue its descent for a while. The slide was arrested though at the lower end of the indicated support shelf (see the first chart above for details). The turning point coincided with a Fibonacci 38.2% retracement of the July 2012 through December 2013 advance. The robust rebound that unfolded in days since the turn argues that the May 29th low is of medium-term significance. Accordingly, I anticipate that returns to Treasury investors over the next few months will pale in comparison to those achieved during the first several months of the year.
With that said though, monthly momentum for $TNX seems poised to decline into 2015, suggesting that while last week’s inflection in rates might be A bottom, it probably is not THE bottom. I do anticipate a time later this year when bonds again look compelling, both absolutely and relative to equities, however, right now it looks as though rising rates will pressure fixed income returns for the next couple of months or so.