“Pitching a curve in long term interest rates” by Harold AGJ Davis in Winnipeg

Old bond traders who cut their teeth in the high volatility vigilante days from 1979 to 1985 seem to have trouble understanding new wave, non-traditional monetary policy. Convinced that “It will end badly”, we have had a tendency to be bearish on the bond market since 30 year Treasury Bond yields first approached 4% back in 2003. More than a dozen years later, the death watch has grown old. Perhaps our classic training prevented us from seeing the situation and the charts clearly.

The thirty-four year old bear market in long term interest rates must end one day. We simply do not know when, how, and what yield level. Various methods have been tried; trend lines drawn, support and resistance plotted, and momentum measures and algorithms scrutinized. Some results have produced profitable trades, but the right clues to predicting a major trend reversal and asset allocation shift remain elusive.

What if the answer was obvious for all to see? Try this:

On a chart of 30 year Treasury Yields, start by identifying the highs of 2004, 2007, 2009, 2011, 2013 and late 2015. Draw a line through them. It should produce a smooth curve slowly accelerating to the downside. Depending upon how you draw the curve, the slope of this slow-motion waterfall approaches the vertical late in 2016 or early 2017 at a yield level around 1.90-2.0%. Certainly, another data point on the curve would offer a welcome refinement. However, because no market goes vertical for long, the important forecast conclusion is that this twelve year old momentum structure is nearly exhausted and a break above the line should signal an important trend change.

Why now? What is special about the next ten to twelve months?

Well, maybe it means that the current policy paradigm will end with this U.S. Administration. What if key departing politicians adopt an “Après moi, le deluge” posture? As for the newcomers, in a recently televised American presidential primary debate, one candidate seemed to refer to bankruptcy as a useful business strategy. That is certainly an interesting perspective for the leader of a country with trillions of dollars in debt. And it is difficult to imagine how another candidate’s campaign promises could ever be funded.

On the other hand, the turn might be caused by something less theatrical but equally dramatic. Credit crunches have worked well in past generations. Will China go bust? How about the oil patch or major oil producing nations? Risks abound and time will tell.

Even a purely fundamentalist valuation perspective could contribute to the changeover. Smart fundamentalist investors know that when the news just cannot get any better, it is time to sell. These days, the European central banks are expanding their quantitative easing approach to monetary policy by adding greater liquidity and buying even more debt, including corporate securities. Throw in the prospect of negative interest rates like the current Japanese policy experiment and it is hard to imagine a better bull case for bonds. Yet, good traders know that when all the good news is “in the market” it is usually time to sell. Watch the curve.

Harold AGJ Davis is the Author and Analyst at   www.prairiecropcharts.com