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Prieur Picture du Jour: Injury Time for U.S. Long Bonds

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Beginning of the end for bullish bond trends.

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Since the advent of the credit crisis, stock markets, real estate and the U.S. dollar have been the subject of investors' angst. However, two markets – commodities and long bonds – have remained in bullish trends. That's at least the way it looked until recently.

The Reuters/Jeffries CRB Index hit a peak on March 13, and I argued in a subsequent post that although a correction was overdue, the long-term trend was still upwards.

But what about the outlook for U.S. bonds, especially as yields have edged up since the recent lows of 3.314% (March 17th) and 4.165% (March 20th) for the 10-year and 30-year Treasury Note respectively?

The graph below shows the long-term movement of the yield on the US 10-year Treasury Note, indicating that long-dated U.S. bonds have experienced a multi-year bull market and are trading at levels last seen more than 40 years ago as far as nominal yields are concerned and 28 years ago in real terms. Thinking of which, the only investors who first-hand experienced the last major bear market in bonds (from 1971 to 1980) are now all on the wrong side of 50!


Source: I-Net Bridge

Let's now turn to a shorter-term graph of the 10-year Treasury Note yield in order to see the recent action.


Source: StockCharts.com


The chart illustrates the sharp fall in the yield over the past few months as investors scrambled for safe-haven investments as the subprime fallout intensified. Although the yield has bounced off the bottom Bollinger Band (bottom green line), no sell signal as such has been given. However, the positive divergence of the Stochastic Oscillator is of some significance as it often acts as leading indicator of the yield graph. Although the 50-day moving average (off-blue line) could provide a short-term barrier, the real test will be the February high of 3.917%, which also coincides with the top Bollinger Band (top green line).

It would be remiss not to also show the weekly chart of the 30-year Treasury Note yield, and specifically to point out the triple bottom that has formed over the past five years, providing particularly strong support in the 4.15% to 4.20% area.


Source: StockCharts.com


Why would long bond yields be breaking upwards (i.e. why would long bond prices be topping out) from a fundamental perspective? Bonds could be discounting better business prospects a few quarters down the line, or they could be discounting rising inflation ahead, or perhaps both. Quite a likely scenario is that we could see a continued base formation for a while longer as the forces of inflation versus deteriorating/improving economic prospects play themselves out.

Time will tell when bond yields will hit a secular low, but in the meantime one should be cognizant of the fact that an investment in a 10-Year Treasury Note will by definition lock in a total return of 3.5% over the next 10 years. This sounds unsustainable and I find it difficult to see the long-term investment merit of such an investment. Long-dated bond prices could be hit hard once yields adjust to more realistic levels.

Be careful – we're in injury time.

No positions in stocks mentioned.
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