To start 2014, we held the very out-of-consensus view that fixed income investors would get a reprieve from the rise in interest rates that was much of the story of 2013. [Our proxy for rates is $TNX, the CBOE 10-Year T-Note Interest Rate Index. Per this measure, 10-Year Treasuries closed out 2012 yielding 1.756%. At the end of 2013, these instruments yielded 3.03%.]
As of the time of this writing, rates are 61 basis points lower than the December 2013 close.
Detracting (a bit) from this deeply gratifying big picture prognostication is the fact that we stumbled a couple of times this summer while trying (prematurely, as it turns out) to call an end to the decline.
Between the bad call we tweeted on Jul 30 (shown above) and the standing $TNX low registered two days ago, 10-year T-Note yields shed a material 21 bps. We have developed a fairly thick skin over the years though, so while we try to nail every call, we realize that predicting unknowable outcomes is invariably going to leave us with egg on our face sometimes. At the end of the day, however, we are confident in our framework and ultimately expect the value of our accurate calls to outweigh costs of our missteps.
With that said, we currently observe conditions that hint that the decline in 10-year Treasury rates might finally have exhausted itself at the mid-August low.
For one, our medium-term, price-based momentum oscillator (our primary timing tool) appears to have bottomed last week. It looks highly probable that this gauge will underpin the trend of rising rates into November or beyond. Our shorter-term momentum measure hit trough levels on August 20 and now looks slated to support rising rates for at least the next 11 periods–as far as the model can forecast.
In addition to momentum, Jake Bernstein’s Daily Sentiment Index (DSI) for the 30-Year T-Bond recently signaled the kind of extremes in sentiment that have historically attended lows in rates.
The June 1995 edition of Stocks and Commodities Magazine includes a study by Lee Ang, then a systems consultant for J.P. Morgan Securities. Ang’s piece, “Back-Testing The Daily Sentiment Index” reviewed the efficacy of this indicator and concluded that trading in and out of the U.S. bond futures markets based on extreme DSI readings generated positive profits, good win/loss ratios and excess returns versus a buy-and-hold strategy. As such, there is a basis for expecting this indication to contain valuable information–especially given the radically extreme nature of the latest peak.
In conclusion, while attempting to call a bottom in rates here might be tantamount to entering the Catch-a-Falling-Knife contest (again), in spite of the scars we amassed for our prior efforts, we like our chances to win (but, then, we always do). While there are other contestants in the tournament (J.P. Morgan and MKM Partners both recently distributed notes advocating negative biases toward government bonds) we think this is still an out-of-consensus perspective. Perhaps counter intuitively, that only a few are looking in this direction modestly increases our conviction.