Eight Hikes Later

Key Points

• Interest rates were kept extremely low in the after math of the Great Recession, which changed the relationship between bonds and stocks.
• The “global search for yield” helped inflate the relationship, and push the assets to extreme levels.
• Now, investors are starting to believe the Fed is going to slow or pause rate hikes in the face of a slower economy.
• Interest rates may have peaked as investors normalize portfolios with more fixed income allocation.

You can read the blog with all of the charts here: https://www.brtechnicals.com/eight-hikes-later/

The Last Hike?

All eyes are on the Fed next week. Investors are expecting a 25 basis point rate hike, but at the same time hoping for dovish comments going into 2019. 

The Fed embarked on their rate hiking journey three years ago, in December 2015, and have hiked rates every quarter since. As interest rates rise back to more normal levels, it will eventually lead to stock market volatility. 

Stocks and bonds are competitors; both assets compete for the same investment dollars available. Over the last 10 years bonds have been less competitive because of the Federal Reserve’s actions after the Great Recession. This has led to more money being put to work in the stock market.

How Did we Get Here?

The Fed Prevents a Depression

The Great Recession took a big toll on the economy, so the Fed went to extraordinary measures to prevent a depression. Essentially, the Fed lowered short-term rates to near zero, and dumped large amounts of liquidity into the financial system. 

Their goal was to raise asset prices to make investors feel richer. Since an economy is made up of its participants, the logic was to make them feel richer so they would be willing to spend more, and generate economic activity. 

With lower interest rates, bond investors felt the affects through higher bond prices. With higher liquidity, stock prices rose. However, the problem created through these measures was a lack of quality yield.

Investors had to move up the risk curve to achieve the yield they needed in their portfolios, or put their money into the stock market for dividends. This provided even more demand for stocks, and helped push prices even more.

Normalizing Policy & Portfolios

Now that the Federal Reserve has been working to raise interest rates back to normal levels, demand for stock is weakening. Bonds have always been seen as a safer, less volatile, investment asset, and now that there is a higher yield, they are more attractive to investors. This is going to cause volatility in both the bond and stock markets as investors rebalance portfolios towards normal.

They key is determining where bond yields are going to go. Investors are more reluctant to buy bonds now, if they will have higher yields later. However, if yields are expected to go down, then now may be the time to buy. 

Now may be the time to buy bonds because the Fed is acting more Dovish and the economy looks like it is weakening. If rates aren’t going to be forced higher, then right now could be the best time for bond investors to earn as much yield as possible.

The Charts

The 2-Year Treasury

The 2-Year Treasury note has broken its minor uptrend, and failed to break its primary uptrend. This could be a sign that the note had peaked around 3%. If the Treasury Note can rally past 3%, then it is likely to continue. However, this would break a 30-year old trend, so it will have a tough time doing so. On the downside, there is a support at 2.6%. If this support is broken, it would signal lower rates in the future.

The 10-Year Treasury

The 10-Year Treasury did break its 30-year trend, but it has since collapsed back under it. It too has found a support, but at 2.85%. If this slopping support is broken, the next one is at 2.6%. This is the same place the 2-Year Note has a support. Could this be the level we see the 2/10 spread invert?

The 30-Year Treasury

The 30-Year Treasury failed to break past its 30-year trend line, and it has broken its first support. However, unlike the previous notes, it has not broken its minor uptrend. If this support fails, then the treasury is likely to test 2.95%. 

Time to buy Treasuries?

These three Treasuries failed to break their +30-year long trend lines, and they may have peaked for this cycle. This means, now is the time to move to bonds from stocks, if they you are overweight. 

And it looks like this is what investors have been doing. Bonds have been volatile since September, which is when the Russell 2000 had started its decline. Seasonality can also play a role, as the new year is the perfect time to move portfolios back into a more normal allocation. 

Treasuries Forecasting a Bear Market?

There is one more chart that may be telling us to expect more downside pressure in stocks:

The last two times Treasuries failed to break their long-term trend lines was in 2000 and 2007, right before two large bear markets. Granted, these two bear markets came off the back of two large bubbles, but a case could be made that we are in a liquidity bubble (read: Unintended Consequences of Easy Monetary Policy). The drops in yield preceded the stock market drops by 6 volatile months in 2000, and 3 volatile months in 2007. Right now, we are 3 volatile months into the latest peak in interest rates.

Conclusion

The importance of interest rates in this economic cycle should not be downplayed. Stocks are going to suffer in multiple ways. Higher rates mean bonds are more competitive for investment assets. They also mean tougher monetary conditions for both individuals and corporations. There is less cash for investors to put into savings and investment accounts, and it makes corporate borrowing more expensive, hurting balance sheets. Overall, this leaves less demand for stocks.

Submitted December 17, 2018 at 07:15PM by BR-Technicals https://ift.tt/2Gpb2NU