Mover Mike

I've told you that I use technical analysis to give me a general impression of a stock, bond or commodities. This afternoon I glanced at the $USB, the chart of the 30 year Treasury (see chart). It startled me to see that the daily $USB has fallen back to the 200-day moving average at 115.

Looking at the Percentage Price Oscillator (PPO),

The Percentage Price Oscillator is found by subtracting the longer moving average from the shorter moving average and then dividing the result by the longer moving average.

it appears that the PPO is about to cross over reulting in a BUY signal. In January, 2008, the $USB went to the highest level since before 1999. Recently, the pullback from 122 to 115, looks like a correction to the main bull market. The chart looks like the rise is ready to resume.

What does all the mean? It means that Treasury Bonds are set to continue higher resulting in lower long yields. It means that interest rates are set to come down a lot! Bonds go up, yields go down.

The lows since since December, 2007 have been 4.26%, then 4.23% and lastly in March, 2008, at 4.17%. We are currently at 4.51%, just off from 4.61%. I could see the long bond trade at 4% and below!

BTW, the Two Year Treasury Yield ($UST2Y) looks like the rally is over. It could go back and test the 1.35% low set in March. It is currently at 2.29% The Ten Year Treasury Yield ($UST10Y) also looks like the rally is over . It could test the low yield of 3.34%. It currently is at 3.77%.

What does it all mean? It may mean the economy is weaker than we are being led to believe. It may mean there is a flight to safety. It may mean that the huge flows of capital directed at banks are finding their way into purchases of safe items rather than take a chance on loaning money.

On April 30th I posted Long Bond Could Trade At 4% And Below! I asked my friend and money manager, Bill, about the meaning of lower yields on Treasuries. Bill wrote me back and said

You may be correct, but I think it is also possible we have a trading range.

We may even have seen the top for bonds and the low for yields. In other words, I think it is completely up in the air. I can't manage much conviction on any of this. I do agree with Bill Gross, the Treasuries have very little value at these levels. His comment was Treasuries are the most overvalued asset in the world. Seems a little strong, but makes a useful point.

I replied:

Let's stand in the possibility that I'm correct, and the charts look more like I am than on April 30th, what is the treasury 2-10-30 year telling us. That's what fascinated me. In the light of record CRB and Oil and grains and weaker USD, shouldn't the treasuries be dropping, interest rates be rising??? Why aren't they?

Bill replied:

A combination of flight to quality and recession talk, both of which might be short term.

Yet, Van Hoisington supports your view, and it has not paid to argue with them - and they are mostly fundamental. Confusing, but fascinating time; maybe the best in 70 or 80 years.

I Googled Van Hoisington and found that Hoisington Investment Company has a Quarterly Review and Outlook.

The Fourth Quarter Review and Outlook states:

The longest-dated Treasury bond ended 2007 at a 4.45% yield. This was 35 basis points below the 2006 close, and marked the lowest year-end interest rate on a long Treasury security in 42 years. The capital gain associated with this yield reduction, plus the coupon, generated a 10 ½% return for investors, well above the 7% total registered by the Lehman Aggregate Bond Index.

The 30-year closed yesterday at a 4.45% yield, which supports Bill's view that we are in a trading range.

The Review continues

The beginning of what will surely be considered the greatest credit event since the 1930s emerged in 2007 with the discovery that derivatives multiply bad credit. The “seizing up” of credit markets resulted in a worldwide reduction of credit issuance from $2.5 trillion in the 2nd quarter to $1.3 trillion in the 4th quarter, a near 50% reduction according to a recent New York Times article. A supply shrinkage of over $1 trillion is enough to shift the supply curve to the left, resulting in a bond price increase and lower yields in high quality fixed income securities. This more than offset an increase in inflationary expectations, and was most likely the proximate cause of the sharp reduction in Treasury interest rates in the latter half of 2007.

They expect either two back-to-back quarters of declining GDP or possibly alternating quarters as we had in the 2000 slowdown. The result:

First, investor desire for risk-free assets will increase at a time when default rates will be soaring on other fixed income securities. Second, the overall reduction in credit market instruments will mean fewer alternatives for those desiring a fixed rate of return. By the end of 2008 we would expect new record low yields in Treasuries for this cycle.

In the Quarterly Review and Outlook, First Quarter 2008 the Review concludes

Thus, if this growth, or outright recession, ends in 2008, the low in bond yields will be some time in 2010. However, if we are in an extended growth recession that lasts into 2009 or 2010, as we suspect, and if rates are at record low levels, similar to the 1940s and 1950s, then the low in rates is likely to coincide with the end of the recessionary period.

Now the BIG QUESTION: are we in a recession? If we are we should start to see prices peaking and we can justify lower yields on treasuries. If we are not in a recession then prices are not peaking and yields should not be falling, but rising and they aren't. Like Bill said "Confusing, but fascinating time; maybe the best in 70 or 80 years."