Bonds, the sell-of-a-generation

The problem with the broader global stock indices is the great 2011 – 2012 yield chase (often referred to as the risk-off trade) still has investors crowding into the pipeline, REIT and telecom space in search of income. The driver is the historical low yields on corporate and government debt in reaction to fears of a global economic slowdown. Over the past two years the yield on U.S. Treasuries maturing in 10 years or longer have declined from over 4% to the current 1.5 % level. Falling government bond yields are due more to investor fear and less on economic reality.

The long decline in interest rates began with the inflationary peak of 1981 which drove the yield of the U.S. Treasuries to over 15 per cent. The subsequent long decline in yields persisted in spite of the savings & loan crisis of 1982, the Continental Illinois Corp Collapse of 1984, the Bank Liquidity Crisis & Black Monday crash in 1987 and the Mexican Peso Crisis of 1994, etc.

Our chart this week spans about one half (fifteen years) of the long decline in the U.S. 10-year Treasury bond yields. The upper and lower parallel trend lines are simply extensions of a 30 year price channel. I have noted the recent series of fear driven lows beginning with the Asian & Russian currency crisis and ending with the current EURO crisis.

Price Channels are long term trend lines placed above and below the price of a security. The upper channel will join trading peaks and the lower channel will join trading troughs. Price channel trend lines must be parallel and they can only be placed using a semi log scale. Price Channels will trend upward or downward and can also identify overbought or oversold levels within a very long downtrend or uptrend. In the example of our U.S. 10-year Treasury bond yields the very long term trend has been down for about 30 years with the lower price troughs representing periods of fear and the upper price peaks representing periods of optimism.

In the example of our long term down trending yield price channel the change in trend would occur when the price breaks up and above the upper price channel which has not yet occurred. What has occurred is very rare. The price has broken below the lower price channel in reaction to the current EURO crisis.

These trend accelerations which are technically rare will occur at the end of a long trend up or down. In other words these tend accelerations are not sustainable and a big jump in the yield price is very probable over the next several weeks. With this in mind we can now go out on a limb and make a top down or macro call on the outlook for interest rates.

If we could refer to the inflationary 1981 price peak in the U.S. 10-year Treasury bond yields to be the buy-of-a-generation in bonds perhaps we can refer to the EURO crisis price trough of 2012 to the sell-of-a-generation in bonds.