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What If the 10-Year Treasury Yield Breaks Its Long-Term Downward Trend?


This is the question that has begun to circulate in the investment community over the last few months.

Our grand business is not to see what lies dimly in the distance, but to do what lies clearly at hand.
--Thomas Carlyle

A glance at last week's tape suggests that nothing seems to have transpired in the market, at least for equity returns. But the question is: Is this the calm before the storm, or simply end-of-summer doldrums? If one were to pull back last week's curtain, it would seem that things are transpiring beneath the surface: the Fed meeting minutes, Ben Bernanke's non-appearance at the annual Jackson Hole Fed symposium, the Nasdaq's (INDEXNASDAQ:.IXIC) flash freeze, and the 10-year Treasury yield surpassing an intra-day high of 2.9% were the highlights.

With the Fed minutes and the Jackson Hole symposium providing no clarity on impending QE tapering, and the flash freeze becoming a non-event, it only leaves the 10-year Treasury yield to ponder. On January 7 of this year I penned a piece which opined that the 10-year Treasury yield may have hit and set its all-time low.

With July 2012's all-time low on the 10-year yield at the front of investors' minds, the talk has turned to a potential "permanent" bottom and a possible break of the 31-year downtrend (since 1981). In my humble opinion, there continues to be too much uncertainty to make that type of call, but the cards are beginning to fall in place and build a foundation for this argument. For now it looks as if 3.75% would be the beginning of the end.

Continuing with this thought, the piece illustrated the following long-term 35-year chart of yield and alluded to 3.75% being the telltale sign of exiting its secular bear market -- the beginning of the end.

That said, there is more to the story, and it's only prudent to evaluate things on a more granular level. The two charts below illuminate the 10-year's intermediate-term trend and the iShares Barclays 20-Year Treasury Bond ETF's (NYSEARCA:TLT) inverse relation. The 6-year chart of the 10-year points out that since the week of May 28 2012's low (1.46%), the increase in yield has been nothing short of astonishing, just over 100%. Meanwhile back at the ranch, the TLT has lost 20% of its value. This becomes displeasing for the Capital Asset Pricing Model (CAPM) due to the fact it uses the Treasury market for its "risk-free" investment assumption.

Sarcasm aside, these charts do technically indicate that there may be some short-term reprieve on the horizon. The 10-year's two illustrated resistance points are 3.75% on the longer-term and in the vicinity of 3.125% on the shorter-term. This is where we would technically expect some consolidation or retracement. Extrapolating this onto the TLT, one could project a support level around $90 - $92. Good news? Try telling the mom and pop retired investors that their continued risk, after a 20% drawdown, is only another 12.5% from here.

With the taper talk all but solidified within the market's landscape, at least on an intermediate-term basis, the aforementioned yield resistance level seems clear enough. But what if the Treasury yield does break its long-term downward trend? What happens then? This, my friends, is the question that has begun to circulate in the investment community over the last few months. Is it really possible for the yield to go back to 6%, 8%, or even to the 15%-plus peak of 1981? It is too early to pontificate about these questions, but they should be on every investor's awareness list as the majority of mainstream asset allocation models (MAA) use this variable when shifting from a risk-on to risk-off stance.

Editor's Note: Read more at Tesseract Asset Management.

Twitter: @TAM_News
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No positions in stocks mentioned.

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