Will Bond Breakout Stick?
Bond prices in the U.S. recently broke out to all-time highs (and yields to all-time lows); a test of the breakout area is presently underway.
As legions of money managers await a test of the S&P 500′s recent breakout level (presumably because they are egregiously underweight equities), another equally important test is underway. In the immediate aftermath of Brexit, prices of several classes of U.S. bonds broke out to all-time highs. Conversely, as they move opposite from prices, yields dropped to all-time lows. As we speak, bond prices are testing their recent breakout levels and yields are testing their breakdown levels.
For example, one of the most popular bond ETF’s, the iShares Barclays Aggregate Bond Fund (ticker, AGG) broke out above its highs from 2012 and early 2015, around the mid-112 level. That level is being tested today.
At the other end, 10-Year U.S. Treasury Yields (TNX), which briefly touched all-time lows at 1.33%, are testing their recent breakdown level from their February and mid-June lows around 1.60%.
These tests would seem every bit as significant as a potential stock market test. Given the momentum and technical structure, bond prices should have no trouble passing this test and continuing higher (and yields lower). Sure, a bit more leeway may be granted to this trend (e.g., 112ish on AGG and 1.75%ish on TNX?). However, this intermediate-term trend has been firmly in place since the beginning of the year and it should continue to receive the benefit of the doubt.
That said, one of these days, the trend will reverse. And while that is the case with all price trends, given the cycle whereabouts of bond yields, i.e., 35 years into a down move, a potential reversal in this asset class could be as significant as any in generations. We have noted in recent months that the conditions for such a reversal have seemingly been gradually falling into place.
Quantitatively, the “smart money” commercial dealers in 30-Year Bond futures have never been more net short (although it is a different story for the 10-Year). Anecdotally, we have “sensed” a psychological shift as well. For over a decade, it has been consensus thought that interest rates had nowhere to go but up. Obviously, with rates at all-time lows, the consensus has been wrong that whole time. However, it seems like consensus has recently come around to the inevitability of “low rates for longer” around the world.
This subjective observation is unlikely to be met with an abrupt change in the 35-year trend. However, again, the conditions for a reversal (finally) seem to be falling into place. Of course, the one thing missing is the actual reversal. So, like everything else in financial markets, the movement in prices will tell the story. And prices will need to fall (and yields rise) by a substantial amount for a long-term trend reversal to be convincing.
However, every long-term price move begins with a small move. And if bond prices fail to hold their breakout levels, the “false breakout” to all-time highs *could* be a good start to a long-term shift.
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The commentary included in this blog is provided for informational purposes only. It does not constitute a recommendation to invest in any specific investment product or service. Proper due diligence should be performed before investing in any investment vehicle. There is a risk of loss involved in all investments.