$TNX - Grindstone Intelligence

August 17, 2020January 3, 2023

U.S. Interest Rates: False Breakdown or False Alarm?

Interest rates in the United States have been falling for longer than I’ve been alive. Now I may be closer to spring chicken than over the hill, but any trend that lasts for more than a quarter century is nothing short of impressive. Let alone one that’s continued for nearly 39 years. But that’s exactly what long-term interest rates have done, sliding steadily lower since reaching a peak of more than 15% in 1981.

For years, it’s seemed a major reversal was inevitable – with the 0.0% lower bound, interest rates could only go so low, right? Of course, that antiquated line of thinking was shattered by the Bank of Japan, and later the European Central Bank, as they pushed lending rates into negative territory. But that doesn’t mean rates here at home are on a preset course for sub-zero levels. For one, Federal Reserve members have been adamant that negative rates are not an appropriate policy in the United States. In addition, price action may be setting up a move higher.

Treasury yields fell from 3.25% in November 2018 to a low near 1.50% by early September 2019. They spent the next few months digesting the rapid decline, briefly threatened to move back higher in December, but then collapsed in early 2020, bottoming near 0.60% in March. Another few months of consolidation followed, and another failed move higher. Recent history looked set to repeat itself, and indeed it did – until it didn’t. Bond yields set a new low in July, but instead of collapsing, they halted their decline and reclaimed the key area of support. Meanwhile, weekly momentum improved even as rates were setting new lows.

So could this failed breakdown and bullish momentum divergence be the long-awaited catalyst to end a generational bull market in bonds? It certainly could, but let’s not get ahead of ourselves. Momentum divergences and reversal rallies have been a hallmark of the long-term trend. Take a look at each decade over the last 40 years:

The ’80s saw a handful of divergences between price and momentum, some larger than others. The first must have been especially interesting at the time. After all, 1981 marked the end of a 30-year uptrend in yields, and no one at the time could have known for sure it was the peak . The bullish divergence in 1982-1983 certainly looked like the catalyst that would spark a resumption in a multi-decade trend, but, alas, the ensuing rally lasted less than 2 years.

Only two such divergences occurred in the ’90s. Each produced a rally, but rates resumed their steady march lower. Of note, one of the largest rallies of the decade was not preceded by improving momentum.

And in the ’00s, 3 more momentum divergences. The largest sparked a 3-year rally that began in 2003, but that rally couldn’t even bring yields back to where they’d been in 2002, just a year before the rally started.

The last decade has been more of the same.

Each of the prior 11 bullish momentum divergences resulted in higher yields, but none had the stamina needed to put an end to the long-term decline. On the other hand, none of the others have occurred this close to the zero lower bound.

Interest rates have been on the rise this month. The only question is, how long will it last?

Nothing in this post or on this site is intended as a recommendation or an offer to buy or sell securities. Posts on Means to a Trend are meant for informational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in posts. Please see my Disclosure page for more information.

July 29, 2019

How Much Does Fed Day Matter?

Eight times a year, thousands of economists, analysts, and money managers tune in as the Federal Open Market Committee releases a statement about their policy decision. We’ve all heard the age old adage ‘Don’t fight the Fed,’ but does Fed day really matter? I decided to take a look.

For this study, I define ‘matter’ as resulting in a peak or trough in prices over a predetermined time period. Put simply, I look for a well-defined change in the trend.

On any given day, the odds that the price of the S&P 500 Index is higher than both the preceding 5 days and the 5 days to follow (a peak) is 5.9%. The odds that a day’s closing price will be the low of the total 11-day period (a trough) is 6.0%. Thus, the odds that any day of trading marks a definitive peak or trough is 11.9% (6.0% + 5.9%). We can use the same logic, with different time intervals, to identify more significant turning points. The table below summarizes my findings for the S&P 500 and the U.S. 10-Year Treasury Yield.

So what happens when we overlay FOMC decision dates? I pulled every meeting and decision date since 1993 and compared it to our baseline data. Let’s look at equities first.

Fed days are about 1.5% more likely to change the trend over an 11-day period, 2.5% more likely over a 31-day period, and have virtually no bearing over a 3 month period. On a weekly basis, decision week is 3.3% more likely to occur while equities are setting 5-week highs, but have less bearing over longer time frames.

The impact on Treasuries is somewhat larger, especially on a weekly basis.

Notably, Fed decisions are more likely to result in yields topping over 11-day, 5-week, and 13-week periods.

The evidence clearly indicates that FOMC meetings do measurably increase the odds of market turning points, but what does a 4.8% (the maximum for any time period in this study) increase in the odds actually mean? It means for that time period over the last 25 years, 11 more meetings resulted in trend changes than what would be implied by the baseline – only one meeting every 2.27 years. Even when we choose the most favorable time period, there’s still a 95% chance that a Fed meeting won’t change the trend.

As someone who reads each FOMC press release and watches every press conference, that hurts. No one wants to feel like they’ve wasted their time. But I’m not yet so cynical to believe the Fed doesn’t matter at all. Given how actively Fed members work to manage expectations, perhaps this is really a tribute to their success in not surprising market participants (that hurts, too. The last thing I want is more Fed talk).

As we head towards another meeting this week, I know I’ll still read the release and watch Mr. Powell answer questions – the backdrop of monetary policy is a vital input to any top-down macro approach. That said, these findings definitely reduce the weight I’ll place on market activity around decisions. I’ll spend more time trying to identify the current trend and less trying to find something that will change it.

What do you think?

Nothing in this post or on this site is intended as a recommendation or an offer to buy or sell securities. Posts are meant for informational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in posts. Please see my Disclosure page for more information.

July 8, 2019

Independence Day Edition: Proud to be an American

There’s no place like home.

Few biases are more difficult to overcome than home bias – the tendency of people to allocate most of their investment portfolio domestically. Any investing textbook can tell you that biases tend to be harmful to your portfolio, but Americans who’ve succumbed to home bias can be thankful.

U.S. equities have convincingly outperformed their international counterparts since the end of 2008.

Bond yields, too, are more attractive domestically. The risk-free 10-year rate in the U.S. has averaged 2.5% over the last 10 years, while similar credits like Germany and Japan, aided by central bank policies, have paid investors substantially less.

From a broader economic standpoint, the U.S. is again an out-performer. A few weeks ago, I wrote a piece titled Bad vs. Less Good. The chart below could have the same title. The JP Morgan Global Manufacturing PMI has dropped below 50, signaling a contraction, yet the reading for the United States is still in expansion territory.

Looking Ahead

The S&P 500, Dow Jones Industrial Average, and Nasdaq all set new highs this week, while most of Europe, Asia, and Latin America are still below previous peaks. On a relative basis (below), the 10.3 ratio level was established as important resistance throughout 2018. After surpassing that level earlier this year, the ratio has consolidated and remained above the support. The underlying trend is still up, but a break back below 10.3 would be a trouble sign for U.S. equities on a relative basis.

Keep an eye on the data and watch the levels, but as you wrap up your Independence Day celebrations, be a little thankful if you’ve been invested in the United States of America.