The end of 2013 saw bond yields at their highs and the US equity markets making higher highs. This came as the Federal Reserve started to finally slow down its asset purchases and, as Citi's Tom Fitzpatrick suggest, has now seemingly turned a corner in its so called “emergency” policy. That now leaves room for the market/economy to determine the proper rate of interest; and, he notes, given the patchy economic recovery, the fragile level of confidence and the low levels of inflation, Citi questions whether asset prices belong where they are today. As the Fed’s stimulus program appears to have “peaked” Citi warned investors yesterday to be cautious with the Equity markets [12]; and recent price action across the Treasury curve suggests lower yields can be seen and US 10 year yields are in danger of retesting the 2.40% area.
Via Citi FX Technicals:
Time for yields to correct lower...
[13]
At the end of 2013 yields finished at the highs of the trend. However the recent attempts to push beyond 3% have so far failed suggesting a double top is in the making as we have seen on many occasions over the years
Support levels are at 2.41%-2.46% which should be tested. A weekly close below there if seen (not the base case scenario at this stage) would warrant further concern.
Interestingly enough, this comes at a time when the Federal Reserve has slowed down its asset purchase program. This reminds us of the last time the Fed tried to end its QE program...
[14]
Yields initially rose and then turned down when the Fed tried to end its emergency QE program in 2010 and 2011. We would not be surprised to see a similar situation playing out, albeit on a smaller scale for now.
The economy was not as strong as expected/hoped for and yields did what they naturally do when the economy is weak and inflation is low…they moved lower. Since the Fed has started to take the “foot off the gas” - which initially led to higher yields - it now leaves more room for the underlying economy to determine the rate of interest
Following the evening star pattern at the highs on the weekly chart and the weekly momentum crossing back down from stretched levels, we would expect a test of the support levels at 2.39%-2.46%
A weekly close below that range of supports would suggest much more concern and the possibility of even lower yields. The double top would then point towards a move to below 2% again (not our base case scenario at this stage).
What will be increasingly important going forward will be the state of the economy (unless of course the Fed has any surprises up its sleeve but we won’t enter that for now). A quick look at some key Techamental charts gives a clue about what could be around the corner...
Consumer confidence turns after going up for 4 year and 4 months
[15]
All three cycles so far have seen confidence rise for 4 years and 4 months before turning down again. Confidence is fragile and at risk of moving down
Mortgage rates and Consumer confidence
[16]
The rise in mortgage rates has in the previous two cycles corresponded with the peak in confidence.
The chart below indicates that the enthusiasm in some parts of the housing market may be a little stretched
[17]
While there has been some recovery, the NAHB Index (ISM of housing) has gotten ahead of itself
The enthusiasm surrounding the housing market appears to be out of place
This is quite similar to 1993 and 1998 where the NAHB Index was “out of line” with housing starts and building permits. What followed was a decent correction down.
Consumer confidence and initial jobless claims
[18]
Typically consumer confidence has moved lower as initial jobless claims rise
Initial claims have recently been making higher highs and higher lows off of a historically low area. Should we see a trend higher begin to materialize, it would be concerning for Confidence.
US Core PCE Inflation
[19]
Doesn’t really argue for much higher yields
US economic surprise index
[20]
General economic surprises look like they are now approaching a peak again.
Only twice over the past 7 years have we been above current levels and they were short lived.
We should note that this index is naturally mean reverting as expectations rise with better than expected data and vice versa. A fall back below zero if seen may be quite important.
Back to markets...
US 30Y Yields...
[21]
As we can see in this long term chart, US 30 year yields rose throughout the course of last year to test the multi-year channel top just under 4.00% (the high was 3.97%)
However yields effectively went there twice, providing a double top setup similar to that seen on US 10 year yields. Again, we can see that double tops have been fairly common on US 30 year yields over the years
While we believe that over time US 30 year yields can eventually take out the 4.00% area, at this stage the danger is that yields move lower to at least support levels in the 3.46%-3.56% area.
US 5Y Yields...
[22]
US 5 year yields posted an outside week down at the highs last week.
Good supports converge at 1.24%-1.27% where previous lows and the 200 week moving average converge.
The 55 week moving average is just below those levels though is upward sloping.
US 2Y Yields...
[23]
Outside week down here on US 2 year yields too
A test of 31 basis points is expected
Overall in an environment where:
- Yields hit the highs of the year at the end of 2013
- The stock market is at the highs and has rallied on the back of on-going Q.E
- The Fed’s “emergency” stimulus has turned a corner / “topped out”
- The US economic recovery is patchy
- Confidence has likely peaked in this cycle
- Inflation is at the lows
We would not be surprised to see a turn in both bonds and stocks over the medium term
US 10 year yields are in danger of moving down to the 2.40% area, with 30 year yields likely to test 3.46%-3.56 and 5 year yields heading towards the 1.25% area
A break of those levels would be a major concern though that is not at this stage expected