- T-bond prices are ripe for a relief rally in March.
- The long-term trend for bond prices remains down, however.
- Strengthening U.S. economy makes bonds a poor long-term bet.
After commanding the financial Market Spotlight in the last 2 months, the rally in Treasury yields has cooled off in the last several weeks and has taken a backseat to equities. Investors are now focused on the impressive rebound in the tech sector and have turned their attention away from Treasuries for now. As we'll see here, though, we likely haven't seen the last of the bond market's spotlight-stealing ways. Although the T-bond market bear hasn't gone into hibernation, it's taking a respite and bond prices have some relief rally potential in the weeks ahead.
With 10-year treasury yields in an established uptrend since early 2016, the return of inflation has been an increasing worry for investors. The story of inflation's return has been enough of a concern for investors in recent months that it was enough to send the stock market into a tailspin in February. The accelerated rise in the 10-Year Treasury Note Yield Index (TNX) in the first two months of this year was the primary catalyst for the stock market's plunge.
In just the last 3 weeks, however, investors have received a much-needed rest from the negative repercussions of runaway Treasury yields. The TNX has established a narrow sideways range (see above graph) lately which indicates a consolidation of its upward trend. The index did violate its 15-day moving average, however, which is a cause for concern in the immediate term (1-4 weeks). The longer-term trend in the Treasury yield index remains firmly intact, however, which means the bear market in bond prices isn't over yet. Accordingly, any declines from here in Treasury yields should be viewed as a counter-trend reaction against the prevailing long-term upward trend.
Confirming that the bear market in bond prices (and bull market in yields) hasn't reversed yet are two of my favorite bond market timing indicators. The first indicator we'll look at is the iShares 3-7 Year Treasury Bond ETF (IEI). Historically, IEI has acted as a barometer for 10-year Treasury yields. When the 10-year yield trend is down, IEI will normally confirm it by trending lower. What's more, any reversal of the IEI price line (shown below) usually precedes reversals in the 10-year Treasury Yield Index (TNX). As long as IEI is in a declining trend, however, bond investors are safe to assume that conditions are unfavorable for buying Treasury bonds and that yields will likely go higher. In the last several months, this ETF has correctly confirmed the prevailing bear market for long-dated Treasuries.
Another important indicator for evaluating the trend in TNX is the 20+ Year Treasury Bond ETF is the Vanguard Short-Term Corporate Bond ETF (VCSH), shown below. Along with IEI, the short-term corporate bond ETF has been extremely valuable for confirming the bear market in Treasury bond prices since last year. It's normally not a good idea to purchase government bonds when short-term corporate bond prices are slumping, which they have been doing for the last several months. As I've stated in previous commentaries, a two-day higher close above the 15-day moving average in this ETF is required to reverse the immediate term downward trend in short-term corporate bond prices. A reversal of this trend would also bode well for a rally in long-dated Treasury bond prices as well as a corresponding decline in Treasury yields.
Yet another prerequisite for a relief rally in bond prices is for the Dow Jones Corporate Bond Index to reverse its recent decline. As can be seen in the following graph, Dow corporate bonds took a tumble in the early part of this year and have yet to recover. Dow bonds are also an important leading indicator for Treasury prices and can serve as a proxy for institutional demand of short-term sovereign debt. Accordingly, bond investors should watch for a rally in the Dow corporate bond index in the coming weeks to let them know that conditions are ripe for a treasury market rally.
Presently the downward trend in Treasury prices is still underway as confirmed by the two graphs shown above. However, a quick survey of investor sentiment on Treasury bonds suggest that a relief rally may lie ahead for T-bonds. According to data provided by Market Vane, the bullish consensus on T-bonds among investment advisors is now at a multi-year low, which underscores how much the bond price decline of recent months has undermined investor psychology. From a contrarian perspective, this suggests a short-term bottom in bond prices may be soon confirmed.
Shown below is a 3-month graph of the iShares 20+ Year Treasury Bond ETF (TLT), a widely used proxy for T-bond prices. If TLT can manage to breakout above its Mar. 1 closing level of $119.32, which is the nearest pivotal high, it would confirm an immediate-term buy signal for TLT per the rules of my technical trading discipline. By pushing above the $119.32 level, TLT would likely pave the way for a short-covering rally in the near term since there appears to be a lot of short interest in the Treasury market right now.
While the odds for an immediate-term technical rally in the TLT are high, the longer-term downward trend in Treasury prices which was established in 2016 should remain intact. Any such rally of Treasury bond prices from here is likely to be temporary, as the bear market in bonds should continue. With the economy expected to continue to improve this year, thanks in no small part to recent tax cuts and fiscal stimulus measures, investors will be inclined to seek attractive returns in areas other than sovereign debt. Those expecting a revival of the long-term bond bull market will accordingly be disappointed. They should instead turn their attention to the equity market, which will benefit far more than Treasuries from the prevailing climate of rising confidence and economic expansion.
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