Could Interest Rates Actually Move Lower?
Rates have been stuck in a range for months, but there are signs they will go down, not up, in the near future.
By Michael Kahn
30-Yr U.S. Treasury Yield
Interest rates on the long end of the curve haven’t really moved since November. The current sideways action seems to be a pause in a new rising trend, but recent action in both the bond market and interest-rate-sensitive stocks paints a different picture. It is now possible that long-term rates could move back down -- despite increases in short-term rates by the Federal Reserve.
To be sure, the weight of the evidence on the charts still makes a move toward higher rates the greater possibility. However, given the market’s inability to get moving in that direction after months of waffling, there is now a viable argument that it may not happen at all.
Interest rates jumped after the election, thanks to the incoming administration’s tax and spending proposals and the presumed higher inflation that would follow. Yet uncertainty over how many of those initiatives will actually happen kept the trend in check.
That’s not news. What’s more important to chart analysis is the consensus view that, later this year, the bond market will once again be on the lookout for deficits and inflation. That would indeed spark an upside breakout in interest rates on the charts.
This is where it gets tricky. Id we set sentiment aside and only consider what is on the charts today, the view that interest rates will head higher is the most likely to be correct (see Chart 1). As we can see, the current holding pattern, which is classified as a triangle, sits right below the trendline drawn from the early 2011 peak.
The longer any market holds near a resisting trendline, the more likely it will be to break out to the upside through that line. That’s because bears can’t take advantage of the waning demand and bulls have time to reenergize.
Of course, that isn’t a guarantee of a breakout, so we have to consider the triangle pattern itself and follow its borders. A move above 3.05%, give or take a few basis points, would break both the triangle and trendline to the upside. A move below 2.98% -- again, give or take a few basis points -- would keep the major declining trend in interest rates alive for a while longer.
Earlier this month, I wrote here that real estate investment trusts (REITs), one of the interest-rate sensitive stock groups, was strong despite the expected rate increase. And at the start of the year, I made the case that income-producing sectors were cheap enough to start buying.
Since then, the Utilities Select Sector SPDR exchange-traded fund (ticker: XLU) has broken out to the upside. REITs have followed suit. Even the iShares U.S. Preferred Stock ETFPFF in Your Value Your Change Short position (PFF) is in a nice rising trend.
Two weeks ago, high-yielding junk bonds broke out, and the iShares iBoxx $ High Yield Corporate Bond ETFHYG in Your Value Your Change Short position (HYG) moved above resistance to a 19-month high. Clearly, investors are interested in dividend- and interest-producing assets. I think that is one of the reasons why the defensive consumer-staples sector, where many stocks offer beefy dividend yields, is ever so slightly beating the broader market, even as the overall stock-market trend remains strong.
Whether the stock market moves into a corrective decline or not, the bond market and stock sectors that offer bigger dividend yields make a case that interest rates can actually move lower before they move higher. I’ll let economists argue whether that means the new administration can get its policies enacted, or that those policies will have the intended effects even if enacted.
For investors, the triangle patterns in the 30-year and benchmark 10-year Treasury yields are critical.
Whichever way it breaks should set the interest rate tone for weeks, if not months, to come.