To Lock in Or Not To Lock In, That Is The Question

If you’re out of stocks and sitting in T-bills, you may have noticed lately that longer term bond yields have fallen sharply. For instance, the yield on the 10 year Treasury note has fallen from 3.20 to 2.75 over the past 7 weeks.

If you’re interested in bond investments, I suspect that you are wondering why I didn’t tell you to lock in those juicy 3%+ yields. Meanwhile there’s been some talk about the Fed slowing, or stopping its interest rate increases. It feels as though we may have missed the boat!

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So should we lock in long term yields now and buy bonds, or sit tight collecting 2.4% or so in short term Treasury bills.

To help you decide, here’s a review of the charts of the 10 year note yield and the 13 week bill rate, along with my recommendation.

Longer term Treasuries have continued a rally begun in early November. The rally has been fueled largely by the big liquidation of stocks over the past couple of months. But despite the cascade of cash out of stocks, short term money rates have been firm.  There’s no sign yet of any real easing of tightening conditions in the money market. The uptrend in short term rates is intact.

I cover this data in depth in the Wall Street Examiner Pro Trader Treasury Updates The extra detail can be helpful if you’re a big income investor, but for our purposes here, the summary highlights are sufficient.

Treasury supply continues to hammer away at the markets, with no help from the Fed to absorb the deluge paper. In fact, the Fed is adding to the problem by pulling money out of the market.

Dealer takedown at the auctions has risen, but less than the increase in supply. The uptake from other major investor classes has also lagged. There are signs of liquidity pressure on both dealers and investment funds. Investor withdrawals from those funds are crimping the ability of the funds to absorb the ongoing flood of supply.

Despite all that bonds have rallied, but only at the expense of stocks.

Technically, the 10 Year Treasury Looks Bullish

The 10 year yield appears to have entered a bullish phase on the 3-4 year cycle. But conditions are not conducive to a long bull run, like they were from 2008 to 2014 when Treasury issuance was falling and the Fed was either directly buying or financing most of the new issuance. Supply was declining, and demand was fully funded by the Fed, essentially for free.

Now the opposite is happening. Issuance is soaring, and the Fed is pulling money out of the markets. These are not conditions conducive to an extended bull market.

Despite that, the 10 year yield is in a sharp downtrend. It corresponds with the selloff in stocks, which is sending cash rotating into Treasuries. On the charts, this appears to mark the onset of a 3-4 year cycle down phase.

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I expect that to be short lived, probably ending no later than the third quarter of 2019, and maybe sooner. 

Keys to how low the move will carry are right here around 2.70-2.75 and then around 2.60. If either of those holds, it would be a bearish signal for the longer haul. If 2.60 is broken, then I’d expect to see 2.35-.40 before the downtrend reverses.

On the monthly chart, the 10 year Treasury yield has pulled back sharply from the trendline from the 1981 peak. It did so after breaking out above the 2013 peak. Such false breakouts typically mark major trend turning points.

However, it’s highly unlikely that we’ll see anything like the moves of the past era when yields would decline for 2-3 years to new lows each time. The driving force behind those moves no longer exists. Supply isn’t declining, and the Fed isn’t buying.

For as long as the Treasury continues to pound the market with heavy supply and the Fed continues to pull money out of the system, it will be difficult for the market to sustain a rally for more than a few months. The money to drive such rallies must come from other investment classes, particularly stocks.

The first target on the monthly chart would be in the 2.50-2.60 area. As short term rates continue to ratchet higher, the 10 year shouldn’t drop much below 2.50, if at all.

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Wall Street Tells You That The Fed Will Slow Rate Increases, But The Market Will Follow Supply and Demand

On Wednesday, November 28, stock traders interpreted remarks by Fed Chairman Powell to mean that there would be fewer rate increases than originally expected. The interest rate on the 13 week bill, which had been soaring, has paused since then, but there has been no downturn. The trend is intact.

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So I would stick with buying and holding T-bills for now, rather than chasing a rally in bonds and locking in a long term rate now.

I will reconsider this month to month, particularly, if the rate on the 13 week bills drops below 2.34. However, for both short term rates and bond yields to move materially lower for a longer period, the Fed would need to start helping the market absorb that supply in a big way. That means a return to QE. And that’s not on the immediate horizon. 

Waves of panic selling in stocks will result in buying of bonds, pushing yields down from time to time, but this can’t be sustained for more than a few months here and there. When the selling in stocks dries up, as it has this week, bond yields will have trouble moving lower. They should begin to reverse to the upside again, probably around mid year.

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