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Bonds are debt instruments that pay owners semi-annual interest payments. The interest payment is fixed at a certain percentage based on its coupon. As interest rates rise in the economy as a whole the coupon value decreases and the price of the bond falls. This revaluing brings the price of the bond in line with other interest rate dependent securities and maintains its attractiveness to investors.
The inverse is also true. Rising bond prices mean falling bond yields, thus the common market perception that interest rates will decline as bond yields decline. It is widely accepted that bond markets are predictive of the state of the economy and the direction of interest rates.
Bearing this in mind we can analyse price action on the US Treasury futures contract for 30 year bonds (US-Spotv on ProfitSource) and try to predict where interest rates are heading. We can then use this information to predict what impact the resulting changes in monetary liquidity will have on other commodities and the share indices. In the face of recent market volatility, it is interesting to note that many asset-backed and mortgage-backed securities trade by way of a yield spread calculated from the 30-year bond.
click chart for more detail
The US-Spotv chart reveals certain basic patterns which can be used in conjunction with Elliot Wave Time and Price projection (TAPP) to facilitate prediction of price movements. Moving from left to right (ignoring the falling channel labeled by the purple dotted lines) and starting around mid June, Treasuries began to rise in price. This heralded the onset of lower interest rates in the US.
The re-pricing of risk in the credit markets and dramatic impact on spreads was felt in the debt markets before the equity markets. Central banks monitor liquidity and lower interest rates are often initiated as economic conditions begin to deteriorate. After trading within a relatively well defined channel, a short-lived false break of the return line occurred on the upside in early September before rebalancing with a false break of the bullish support line in early October. This false break was halted by support at around 110 and the formation of a second bottom in a double bottom pattern. We are now in the expected rally away from this double bottom. The next major test for both the target of this double bottom and previous resistance zone remains around the 114 mark. If this holds, the uncertainty and associated volatility in the credit, share and bond markets is likely to continue in the US. A breach of this level, however, will signify the start of a bear trend in US equities and the start of a bull run in the form of a flight to quality assets.
Stay sharp,
John Jeffery
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