Tharp's Thoughts Weekly Newsletter (View On-Line)
U.S. Treasury Yields: How Long Can the Drop Last? by D. R. Barton, Jr.
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Yen Crossing Opportunities
Since the summer of 1998, Japan’s deflationary economic environment has kept the Japanese Yen (JPY) strong against all other major currencies. The strong Yen had a positive effect for Japanese capital owners. They imported products at relatively low prices (in Yen terms) and as the Yen strengthened, it also increased their wealth in terms of other currencies. The strength of the currency was one of the main reasons why Japan government bond buyers were willing to accept such low yields. On the other hand, the strong Yen was a long term destructive force for industry in Japan. Japan’s export companies were confronted with uncompetitive prices overseas for their products.
About two years ago, the Japanese government decided (under guidance of Prime Minister Shinzo Abe) to stimulate the economy through an aggressive monetary-easing policy in order to support Japan’s competitiveness (popularly labeled “Abenomics”). This monetary expansion was intended to lead Japan out of the deflationary cycle by weakening the Yen and, thus, creating a competitive advantage — so-called “healthy inflation”. As a direct consequence of Abenomics, exporters have generated better sales and enjoyed higher profit margins due to the falling prices of their products for foreign customers.
Since the implementation of Abenomics, the JPY has been devalued heavily. Against the EUR, it dropped by 55% and against the USD, it dropped by about 35%. On Forex price charts, the JPY devaluation looks like a very strong and smooth uptrend against other currencies for the last two years. During this uptrend, moving average crosses have presented a number of excellent low risk trading opportunities. The charts indicate the possibility of a change now, however, and the question on everyone’s mind is, “What happens in the next two years?”
The Uptrend Continues?
While the previous trend for a strong Yen lasted 16-years, the Bank of Japan’s (their central bank) monetary-easing policy produced a definite change in direction in the last two years. You can see the results shown in the weekly charts (see below): All 4 charts show a very strong and smooth uptrend. For nearly two years, the moving averages have paralleled each other with 8, 21, 40 and 50 EMAs neatly stacked on top of each other. Price has respected the 21MA as a major support area on multiple occasions as well as a sign of a very strong trend. This situation has also created a profitable playground for trend-following strategies.
The burning question is, are these extraordinary trends going to continue for another two years? It is possible, but from a charting perspective, it is not so likely. Every strong & smooth trend encounters a more pronounced pullback at some point before the trend regains strength again. Pullbacks of 50-60% are normal & healthy in a trending market and that may happen for the Yen soon.
Detecting Turning Points in Trends
I am a strong advocate of trading with the trend. There are, however, two types—well-established trends and early trends. Although trading in established trends is my preference, trading early trend reversals can be very profitable. This means that although there is a uptrend in the higher timeframe (such as the weekly chart here), you can find a good downtrend in lower timeframe charts — eg 15, 60 or 240 min, which then leads the way to an overall weekly pullback short.
What are the beginning signs of a pullback? The line in the sand is the 21EMA- the most important moving average currently. Another key sign would be when price no longer respects the 21 EMA. As seen above, the EURJPY seems to play (followed by the USDJPY) a leading role. The blue line (21EMA) has been broken for the first time in two years by a candle close (see last red bar before the current one on the chart below). Although small, this is a noticeable event that might indicate an early trend reversal. To further investigate, traders have to drill down to lower timeframes that should give clues to support this early suspicion.
Should this early indication be proven right, a good number of Busted patterns (setups for my system 1) should occur. The busted breakout pattern gives, apart from situations in mature trends, a good number of opportunities in beginning trends. Now, the market might be in the right psychological mood to do exactly that and turn around.
Early Trend Reversal Indicator – Busted Breakouts
Busted patterns are specific chart formations that profit from breakout failures in which both the long trader/investor is trapped in a losing trade while, at the same time, the short trader/investor is trapped out of a good trade. This situation of a “double trap” leaves psychological footprints in the market and offers great low-risk trading ideas at a specific price level.
Let’s have a look at the 240 and 15min charts of the EURJPY:
The triple high (240min) prices have moved down in a decisive way. Consequently, the MAs have come into correct order indicating an early downtrend. The correct chronological order of moving averages (8<21<50MA) in 240min timeframes is a requirement needed for a Busted pattern to be tradable in the 15min chart (see below).
Indicated by the red horizontal lines, three Short Busted pattern trades have developed consecutively. Very often a Busted pattern is followed by another one in the same pair and timeframe or that of another pair and timeframe. Since Weekly chart is in an uptrend, I would qualify it as the beginning stages of trend reversals - all of these setups were tradable as you can see by the subsequent red candles down to a lower level. Busted patterns come in swarms (just like the giant squids) and there might be others coming in other Yen crosses. On May 16th, a long-stretch busted breakout pattern (which is difficult-to-trade) developed in the USDJPY (15min).
For the time being, both EURJPY and USDJPY are in early reversal mode, with GBPJPY, NZDJPY and other JPY pairs potentially following. Therefore, additional trading opportunities with the Busted or other trend-following systems might develop.
How Far a Pullback?
The EURJPY chart offers room for a 25% correction until the next decent support level at 130. In this case, several good trend-following opportunities should occur on the 5, 15, 60 and 240min timeframes.
We should now be able to observe how things will unfold. There is no certainty in the capital markets, but some psychological constellations offer a higher probability than others. I think there is a good chance that JPY will strengthen across all Yen pairs in the next few weeks. Should, however, price break above the May 12-16 weekly red bar, a continuation of the uptrend would be then most likely.
Please note that while early trend reversal pattern trades tend to have a higher expectancy, they also have lower winning probabilities. Once they run, however, trades with a new trend may deliver a very nice reward over time. Decide for yourself if you prefer trading/investing in well-established trends or trend reversals—trying to trade both kinds of moves can be very challenging for newer traders. As a general comment, trading with a clear trend is better to start with; however, trend reversals should not be ignored.
I hope this helps you understand some ways to think about trends reversals and provided some insight for identifying some good low risk trading opportunities.
All the best,
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U.S. Treasury Yields —
How Long Can the Year-to-Date Drop Last?
With the S&P 500 making new all-time closing highs in the last ten days, U.S. bond prices continue to amble forward as well. And this means that the rate the U.S. has to pay for 10-Year Treasury Notes continues to drop—even sneaking below the psychologically important 2.5% rate level for a short time last week.
Many pundits expected 2014 to be a year for a continued rise in U.S. Treasury interest rates (like much of 2013 was, and they’ve been sorely disappointed. And those who thought that 10-Year Note rates are as low as they could go should think again.
How long can this rate drop last?
There are some good signs that U.S. rates can drop further. The anonymous blogger at wallstreetrant.com provides us with an intriguing comparison of current 10-year yields for various countries:
It’s actually pretty amazing that so many countries sell their debt at rates cheaper than the U.S. Some are with fairly good reason — Draghi’s backstop of all European debt shows up clearly here with multiple entries. (It was Germany reiterating its support for Draghi’s policies that caused rates in general to swoon and U.S. 10-Year yields to drop below 2.5% briefly last Thursday.)
But come on people, France and the Czech Republic trading at yields 83 and 88 basis points below the U.S.? Really? And that’s not all! Though the much discussed PIIGS countries were in danger of default only a few years ago, several are now trading within a stone’s throw of the U.S. rates. Italy’s 10-year note is only 75 basis points above the U.S.’s current rate and lowly Spain is only 57 basis points above! (To clarify these units: there are 100 basis points in 1.0% yield—each basis point represents 1/100th of a percent.)
Of course, this seemingly out-of-balance state could resolve itself by European rates moving higher. But looking at the chart above, it’s crystal-clear that U.S. yields certainly have more downside available. A quick look at a rate chart shows us that we’re certainly far from a bottom:
While it’s true that we’re well below the yields from 2006–2007, we’re also more than 100 basis points up from the lows set in 2012.
There are several factors that could keep rates low:
- The perception of inflation being under control for the long term.
- Geopolitical unrest in the Ukraine (giving investors a “flight to quality” mentality which drives up bond prices and drives yields down).
- Ditto for China flexing its muscles in Southeast Asia where they have been picking fights most recently with Vietnam and earlier with Japan.
- General Central Bank support that has most notably included the European Central Bank, as mentioned earlier, but is also apparent at the Fed, Bank of Japan, etc.
In short, with the all the reasons above coupled with the stock market rotation out of high volatility growth names and back into blue chips and defensive sectors, this isn’t a great time to try and pick a bottom in Treasury yields.
As always, your thoughts and comments are always welcome - please send them to drbarton “at” vantharp.com
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