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The most important question on the lips of traders and investors across the globe is, quite simply, “When will we see an end to the turmoil?”. Back in October, I first demonstrated that the US bond markets were pricing in the high probability of a recession in "Reading the economy through bonds, 26.10.07” and it is now widely agreed that this has come (or very nearly come) to pass some two financial quarters later. A huge amount of liquidity has been injected into the financial credit system by several central banks and this will invariably have some effect on the economic condition of the US. It is this subject which deserves most attention now and shall be examined throughout the interest rate markets. The US 30 year bond chart has recently begun to indicate that the worst may well be behind us and the drastic and unprecedented measures taken by Bernanke’s Fed might pay off as early as the second half of this year. Equity markets are leading indicators and could begin to price this in over the next weeks – so without any more shocks, we are reaching a base line from which to move up again.
The chart of the US 30 year bond clearly shows an instrument in a solid rally since June, anticipating a weakening economy and the coincidental interest rate cuts, the relationships of which have been described in previous articles. Elliott waves (marked as a series of letters and numbers) indicate that a ‘five’ has completed and the first stages of an a, b, c are well under way. In accordance with the theory, W5 has extended to almost exactly 100% the range of W3, giving extra confidence that the described count is the most probable. The final part of the pattern (denoted by the ‘c?’) is yet to confirm, however a break of the bullish support line will be testimony to this and a fall in bond prices may ensue.
click chart for more detail
The final pieces to note from the chart are the formation of a head and shoulders pattern (illustrated by the triangles and ellipse) which appears to be near completion as does the large isosceles triangle (although the breakout direction remains unclear). The head and shoulders clearly imply that the trend is indeed coming towards an end, whereas the triangle’s impact will not be clear until after a breakout.
Time will tell if the predictions made by the bond market that interest rate cuts are close to an end are correct or otherwise. Time will also tell if the end of the dovish Fed policy is because of the result of positive factors (such as an improvement in economic conditions), or negative factors (such as cost push inflation from commodities leading to stagflation). Regardless, with such a proactive Fed and fiscal stimulus hitting the US populace in May, the most likely result does seem to be, that we are nearly there.
Stay Sharp!
John Jeffrey
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