Bond bull market still intact despite rout scare

THE bond rout scare has returned to the market as the 10-year Treasury yield flirts with the 3.00 per cent psychological round number. Many analyst and pundits are calling for the end of the 30-year bond bull market if the 3.00 per cent round number breaks to the upside which is partly the reason why the US equity market is also being negatively affected lately.

However, the exact level that needs to be breached in order to kickstart the bond bear market is the January 2014 high of 3.05 per cent. The recent price action on the 10-year yield has broken above the 3.00 per cent round number but has yet to test the 3.05 per cent level. In other words, the bond bull market is still intact until we get a daily close above the 3.05 per cent level, followed by a weekly and monthly close above that level for further confirmation of a monumental trend shift. Keep in mind bond prices move inversely to bond yields. Hence, a rising yield represents a falling bond price while a falling yield represents a rising bond price.

Based on our study, a few factors are pointing to the 3.05 per cent level remaining intact.

Currently, the market is extremely positioned on the short side of the bond complex, especially the 10-year Treasury bonds. Historically, when the net speculator futures positions exceeded below -210,000 contracts, short squeezes tend to happen, leading to a rise in bond price and a drop in yield. Hence, with the current net speculator futures positions entering into the extreme short side again at -372,000 contracts, a short squeeze in the 10-year Treasury bond is imminent. That should put a cap on the current bullish momentum with the 3.05 per cent acting as the ceiling.

On the price front, the current picture looks supportive of seeing a near-term top too. With the recent break above the 3.00 per cent psychological round number, the weekly RSI has entered into the overbought condition once again. RSI measures momentum. A reading above 70 represents an overbought condition while a reading below 30 represents an oversold condition. Historically, going back to 2000, the 10-year yield tends to react spontaneously to an overbought RSI. Whenever the weekly RSI exceeds the 70 overbought condition, a mean reversion lower inevitably happens. Since 2000, there were only five occasions where the 10-year yield entered into the overbought condition. All five occurrences perfectly signalled for near-term tops in yield. On average, the yield fell -22 per cent.

Therefore, with the recent rise in the 10-year yield leading to the RSI once again being in the overbought condition currently at 70, we expect a mean reversion lower to take place soon. Using the average mean reversion of -22 per cent would translate into a 10-year yield of around 2.35 per cent.

Taking an alternative view on the RSI also reveals another interesting bearish view on the 10-year yield. If the 3.05 per cent resistance area holds, then we could very well be seeing a bearish divergence. In the week ended Feb 16, 2018, the weekly RSI hit a high of 74. Since then, the RSI has formed another Lower Highs (LH) while the 10-year yield continues to establish another Higher High (HH) shown by the diagonal line in the charts. The last time we saw a similar bearish divergence was in 2013, shown by the highlighted box. The 10-year yield topped out at 3.05 per cent in January 2014 after forming a third Higher High (HH) point while the RSI completed the formation of the third Lower High (LH) point. As a result, the 10-year yield fell to a low of 1.64 per cent over the following year.

In summary, with the extremely short positioning in the speculator space and overbought weekly RSI, we expect the 10-year treasury yield to find a near-term top near the 3.05 per cent level with a reversal back below the 3 per cent range. On the flipside, as long as the 3.05 per cent level in the 10-year treasury yield holds, the 200-day moving average in the Dow Jones Industrial Average, S&P 500 index and Nasdaq 100 index should hold too, thus bringing back the risk-on environment.

Disclaimer: Chartpoint is provided by Phillip Securities Research for information only, and should not be construed as investment advice.