Macro Overview Part One: Interest Rates

Big Four Overview: Part 1: Bonds

I begin each year reviewing the long term technical positions of the "Big Four." 10 Year rates, SPX, Commodities, and the US Dollar. Since by profession I am a rates/credit portfolio manager and trader, I always start there. Granted, macro doesn’t typically impact shorter term (swing, daily and weekly) trading, having a framework for markets and for recognizing change is important.

In coming weeks I will look at rest of the big four and at the shorter time frames.

A reminder that falling bond yields are synonymous with higher bond prices. In other words, a downtrend in yield = a bull market in bonds.

1) Over the last four decades bonds have consistently and reliably made lower highs and lower lows. The entire bull market has been defined by a broad declining channel (A-B, C-D).
2) The A-B line represents the "stride of demand" or the zone where buyers have consistently emerged.
a. In October 2018 bonds pushed modestly above the demand line. While not a clean break, it did weaken the TL and suggested that sellers were becoming more aggressive.
3) The C-D line represents the "overbought line" or the zone where supply has consistently emerged and buyers (sellers) have been willing to book gains.
a. In March of 2020 bonds pushed to the area around the center of the channel, but failed to push lower into the overbought line (C-D). The failure is a very visible change of behavior.
4) There is growing evidence of change in the markets character, but the bull trend is intact. Importantly there are NO OVERTLY bearish behaviors visible. To mark a trend of this magnitude as complete would require a clear sign.
5) Note that bottoms are a process. Historically bond market bottoms have taken a decade or more to complete. I currently believe that the pattern since June 2012 is part of this bottoming process.
6) A clear break of the downtrend would change the long trend from bullish to neutral. It would then take a move above the 3.25% pivot to begin defining a long term bear market.

Bottom Line: The market may be on the verge of a trend change, but until overtly bearish behaviors develop, neutral and bullish views continue to deserve the benefit of the doubt.

There are several key fundamental points around rates.
1) The defining macro characteristic of the 40 year bull market has been the continual fall in the inflation rate. If that is changing, the bond trend is likely to also change.
a. If the trend in inflation is changing, the negative correlation between bonds and equity that drives 60/40 allocation and risk parity investing is likely to flip and become positive. In other words, bonds and equity would rise and fall together destroying the diversification benefit. This has been the historical norm.
2) Most substantive bond rallies have been the result of a crisis that created a flight to quality.
3) In an economy that is overly financialized and debt burdened, rising rates often break the weakest link in the economic chain, creating a new crisis and a subsequent flight to quality rally.

Good Trading:
Stewart Taylor, CMT
Chartered Market Technician

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