WEDNESDAY, JUNE 23, 2010
Inflation Will Have to Wait
By MICHAEL KAHN
The bond market suggests that continued economic concerns are keeping yields and consumer prices under control.
TREASURY BOND PRICES are heading higher. Given patterns on the charts of Treasury securities across the maturity spectrum, it is not a difficult conclusion to draw. And since bond prices and yields move inversely to each other, investors will find stingy income-oriented investments getting stingier.
Using an exchange-traded fund as a proxy, the long end of the yield curve -- bonds maturing 20 to 30 years from now -- is in position for a major upside breakout in price (or a downside breakout in yields).
The iShares Trust Barclays 20+ Year Treasury Bond Fund (TLT) just moved higher from a short-term indecision zone and is now bumping up against a critical resistance level (see Chart 1). The round number price of 100 brought out the sellers in droves on many occasions over the past two years, so a move above it now will be a very bullish event.
Chart 1
The only time this happened before was during the panic phase of the financial crisis in late 2008. There are no charted resistance levels until roughly 108 and that would be a huge move in the bond market. It would also drive yields down to the 3.40 area from its current 4.05 -- another huge move and one that is usually reserved for times of financial instability.
In his presentation at the recent Market Technicians Association market-forecast panel, Michael Krauss, head of global fixed income and US equity technical analysis at J.P. Morgan Securities, said that the 20-year secular up-trend in Treasury bond prices is still intact. I interpret this as an environment where the hint of short-term panic buying of Treasuries exaggerates the trend already in effect.
The shorter maturities of the bond market may be even more telling. Long-dated Treasury bonds are considered to be default risk free. If investors move on to gobbling up short-dated Treasury notes and bills, which provide little or no interest-rate risk as well, then these markets will sound an alarm.
For example, shortly after the Federal Reserve released its policy and outlook Wednesday, the two-year Treasury note yielded roughly 0.66% (see Chart 2). This level is on par with the twin lows of December 2008 and November 2009 at 0.65 and 0.67, respectively.
Chart 2
Should this short yield move below these previous lows and stay there, many will view it as a sign of real trouble for the economy. It would mean that investors expect the Fed to keep interest rates low even longer than the Fed intimated in its report, and that would not be an endorsement for any recovery.
Krauss found an equivalent in the benchmark 10-year Treasury note to give us key levels at both the long and short end of the maturity spectrum to watch like hawks. He said that a move below 3.00-3.10 in the 10-year yield would also spell trouble for the economy and the stock market. Wednesday, the yield was at 3.12%.
Treasury securities are not the only places in the bond market that are starting to hint at coming economic problems. The corporate bond market also shows some changes that suggest investors are getting more nervous. For example, John Kosar, director of research at the institutional analysis firm Asbury Research.com, noted in his current report that the spread, or difference, between Baa-rated corporate bonds and Treasury securities has begun to widen.
Baa is the lowest quality rating given by Moody's Investors Service to bonds still considered to be of investment grade. When the spread to Treasuries widens it means investors demand more yield to buy bonds they feel are less desirable in the current marketplace. In other words, they want a higher return because they perceive higher risk on the horizon.
Indeed, this shows up in charts of two popular corporate bond ETFs -- the iShares iBoxx $ InvesTop Investment Grade Corp. Bond Fund (LQD) and the SPDR Barclays Capital High Yield Bond ETF (JNK). While the former is threatening an upside breakout similar to that of the Treasury ETF, the latter has started to weaken (see Chart 3).
Chart 3
To be sure, in 2008, all varieties of corporate bonds fell sharply in price while Treasuries rallied sharply. In the current environment only riskier types of bonds are weak. Further, there is the lack of a seized credit market where lending virtually stopped, so 2010 is not exactly like 2008. But for investors looking for clues about what to do with their portfolios, the bond market, and especially the Treasury market, should be the place to watch.
For now, prices of quality bonds are on the verge of heading higher and that means interest rates are on the verge of heading lower. Inflation will have to wait as the economy seems to still be in the woods.
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