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Why the Reflation Trade Looks Overdone


No, Alice, treasury yields likely aren't going to the moon -- at least not anytime soon.

Last week's treasury rally was the biggest in 8 months, notes Bloomberg in Treasuries Rise Amid Flat Consumer Prices, Declining Confidence.

"Ten-year notes headed for their biggest weekly gain in almost 8 months after the Reuters/University of Michigan preliminary index of consumer sentiment decreased to 63.2, below the 69 median forecast of economists surveyed by Bloomberg News. Compared with a year earlier, consumer prices dropped by the most since 1950."

Once again, the dip in consumer confidence was "unexpected." Economists simply haven't grasped changes in social mood. Others have.

Prices and Social Mood

Last Friday, Professor Depew talked about prices and social mood in an excellent rendition of his column. In case you missed it, please consider Five Things: Do We Need Debt to Recover?.

My post, Misguided Worries About Inflation touched on similar themes.

With stores such as Walmart (WMT), Safeway (SWY), Nordstrom (JWN), Abercrombie & Fitch (ANF), and American Eagle Outfitters (AEO) lowering prices in the face of declining consumer confidence about jobs, and with the reflation trade in the indices as noted by the S&P 500 rally (SPY) starting to falter, one might expect treasuries to rally.

$TNX - 10 Year Treasury Daily Chart

Click to enlarge

The daily chart shows the uptrend line in yields from the December 2008 low has been breached. One shouldn't treat these breaks as "bibles" because at this point, the break can be a meaningless blip. However, this break is an early warning signal to treasury bears.

The weekly chart is more interesting.

$TNX - 10 Year Treasury Weekly Chart

Click to enlarge

From 2000 until mid-2007, 10-year treasury yields meandered along a very flat "calm before the storm" 200 EMA (Exponential Moving Average). In late 2007 there was a significant trendline break and yields plunged to all-time record lows across the entire treasury curve.
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