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The majority of analysis conducted thus far regarding US bonds has been undertaken on the 30 year part of the curve. As an indicator of interest rate movements, mortgage health and the general liquidity of money in the financial markets this has given us plenty of insight into the direction for equity markets in this current credit crunch. It is now an appropriate time to slip back down the yield curve to see what we can glean from the 10 year Treasury note.
Again, the real key to understanding bond market analysis is to appreciate that bonds are interest rate instruments. The inverse relationship between price and yield dictates that should prices rise, yield has to be falling and vice versa. A lot of US corporate debt (also known as credit) is priced relative to the 10 year Treasury note. When we hear that credit spreads are widening, corporate bonds are becoming ‘cheaper’ relative to quality bonds such as the US Treasury, so it is a topical place to do some current analysis.
Since around the 25th of January (see the article ‘US Focus’) the bond market was expecting a sideways or slightly bearish movement in prices (a pull back on the bigger trend of falling yields). As expected this unwinding resulted in positive inflows into the equity markets. The chart below implies that if the current trend line is going to hold – shown as potential support – we may see money flow from equities and back into bonds. Yields will again fall and so too will equity markets.
click chart for more detail
The chart of the 10 year note simply illustrates a regression line with a 2.5% percentage channel enveloping the majority of price action. If prices find support and bounce, yields will fall as the market increases the expectation of further interest rate cuts to support a weak economy. This would also be perfectly in line with reported data from the US over the last few weeks, further strengthening the argument.
Analysing bond markets to understand the general flow of money between asset classes is one tremendous benefit of intermarket analysis. In bull and bear cycles the percentage of capital invested in a share portfolio and the constituents of that portfolio will have a huge effect on an investor’s average annual returns – rather than simply “buy and hope” – as well as direct traders towards the best areas for profit. Identifying the position within the business cycle, the right sector and the best shares within that sector from both a technical and fundamental perspective increases the probability of surviving and even prospering from the current conditions and this is something we hope to provide for our clients with integrated investing.
Stay Sharp!
John Jeffery
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