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Happy birthday to our much quoted and well known friend: the Sub-Prime crisis. As bigger brother of the “credit crunch” it might be interesting to note that the Sub-Prime crisis is already a whole one year old. It is because of this anniversary date (and Gann followers are well attuned to anniversaries) that it is appropriate to check the health of the US interest rate markets and look for clues to see how many more birthdays we can expect for this particular beast. As in previous articles we will investigate the US bond markets.
From a technical perspective the US 10 year note (TY-Spotv in your ProfitSource) tracks the progress of sustained interest rate cuts (and the expectation of cuts) by the Federal Reserve Bank in the US. With the first whispers of a liquidity crisis and problems with collateralized debt instruments, the Sub-Prime crisis, the 10 year note has continually risen in price as lower yields have been factored in.
Chart 1
click chart for more detail
Around April and March this year, following some 15% rise in prices, the well defined price channel began to break down and a head and shoulders pattern materialized. A new channel has now become apparent (delineated by the red dashed lines) which is declaring the market’s expectations that the Fed is finished with its dovish, loosening bias.
Chart 2
click chart for more detail
By zooming into this chart, a level of horizontal resistance becomes evident. It could be expected that this level (around 114.5) may act as a barrier to price rises within the confines of the bearish channel. Although it is not guaranteed, it certainly is worth watching closely for tests or even potential breakouts should the bearish resistance line (upper red dashed line) become pierced.
Regardless of potential market action, the conclusion that we can derive from this set up remain bearish for bond prices and bullish bond (therefore interest rate) yields. This will eventuate in one of two ways and will be drawn from one of two diametrically opposed arguments.
First, the market believes the economy is set to turn and needs no further liquidity injections from the Fed. The current soft patch will be short lived and the reported economic data is reflecting current weakness not future strength. Second, we could be seeing the start of a very dangerous period in time for the global economy. An increase in commodity prices could be leaching into consumer prices and causing inflationary pressure. Food and energy shortages and increased demand is also contributing to this phenomenon. The first birthday of the Sub-Prime crisis might herald the birth of stagflation.
Stay Sharp,
John Jeffery
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