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US Treasuries will decline
As 2014 started, the prevailing opinion was that Treasury yields were set for a huge decline. The reason? The largest buyer in the market – the US Federal Reserve bank – announced it would be gradually winding down its monthly QE purchases of bonds and ending the scheme in October. Naturally, with the biggest buyer leaving the market, who was there to take up the slack?
Obviously, the no-brainer trade was going to be short Treasuries, banking on rising yields.
But a funny thing happened on the way to those rising yields – the market defied common sense and continued its bear trend in yields into 2014. In fact, 2 January marked a major high in yields and the trend didn’t stop until October.
That caught many prominent pundits – as well as major bond funds who had bet the wrong way – with either egg on their faces or major losses.
In fact, that 2 January high in yields was the end of the final fifth wave up from the 2012 lows. Not only that, but the DSI (Daily Sentiment Index) bullish readings were plumbing depths rarely before encountered – well under 10% bulls for several months. Almost everyone hated those bonds!
So the scene was set early in the year for a massive surprise to the majority. I happened to recognise this technical picture and began a campaign of trading Treasuries from the long side, looking for yields to decline. It was my perfect contrary trade.
My scenario for 2014 was this: the market’s lack of concern over deflation and with world economies slowing – as reflected in declining commodity prices – I believed consumer prices would fall in 2014, especially in Europe. This would force bond prices higher and yields lower.
And any bonus would come if stock markets took fright during the year (a most likely event) and drive investors into the safety of Treasuries. In fact, this did occur in late January, July and October.
So where are we as 2015 approaches?
My forecast for Treasuries
In terms of market sentiment, the picture is completely reversed from that of a year ago. Now, bullishness has been touching well over 90% for some months, and opinion is firmly fixed that Treasuries can only continue rising.
Naturally, this is a red-rag-to-a-bull moment for me and is setting me off looking for the contrary trade.
Now, let me examine the technical picture. Here is the chart of the ten-year Treasury yield going back to before the Great Depression:
Quite a mountain, isn’t it? From WWII, rates established an uptrend as consumer credit expanded and consumer price inflation became a constant theme in the 1970s especially. This culminated in the early 1980s in the almost hyper-inflationary peak with over 15% yields.
But that was the top, and since then, rates have been in a massive bear trend for over 30 years as disinflation became the major theme. Then, in 2012, an all-time low in yields was achieved, but that was a major support level created from the Great Depression lows.
My conclusion: in the long-term picture, yields have reached major support. The trend will now be up.
To confirm this scenario, I need to look at the shorter-term picture:
Chart courtesy www.elliottwave.com
The 2 January 2014 top was well flagged by the sentiment divergence (red bars). The October plunge in yields was the final bottom in the large wave 2 down and since then, we have waves 1 and 2.
If this labelling is correct, we are currently in a third of a third up. This is the most powerful pattern in the Elliott wave book, suggesting huge rallies in yields in 2015.
Let’s take a look at the hourly chart of the March T-Bond (30-year):
If these labels are correct, the market is on the verge of a huge decline. The key level is the 146.50 high. If this level is exceeded, that would negate all of my labels. But with the hourly momentum overstretched, the most likely path is down.
- My first trade for 2015 – short US Treasuries.
My second trade for 2015 – the US dollar
As a small bonus, I have another trade for 2015. It is the US dollar. Long-time readers of my emails will know that I have been bullish the dollar for many months – long before the current craze for it got off the ground. In fact, it was one of my trades for 2014.
But that is tempered by my belief that today, it is in grave danger of suffering a massive correction. My proxy for the dollar is the inverse EUR/USD trade.
This is the update of the long-range chart I have shown recently:
The market is at the 1.22 level, which is right on the nine-year support line – and my target when the market was trading at the 1.40 level earlier this year.
Here is the close-up of the waves off the 1.40 high:
Last week saw a resumption of the fifth wave, but the end is nigh! Take a look at the massive potential positive momentum divergence. This strongly suggests that when the fifth wave low is in, the move up will be very sharp.
Also, sentiment towards the dollar is still very bullish. This makes sense in that many overseas investors want to escape from their own currency turmoil in the petro-currencies.
- My second trade for 2015 – first short dollar, then long dollar.
What to watch out for?
What could be the catalyst for a turnaround in the dollar and in the US Treasury market? One possibility is a recovery in the oil price. Opec could decide to cut production, and with some high-cost fields out of production already, that would have a massive upward impact on the oil price. Bearish sentiment towards crude oil is running at extreme levels and so is primed for such an event.
If this occurs, I expect gold and silver to catch a bid and rally through my first gold target at $1,250 and towards $1,300.
Ironically, an oil price recovery would send stocks lower with the dollar. And wouldn’t it also be ironic that exactly one year later in the first week of January, Treasuries could make a major turn down?
This is my final Trader email for this year. I want to wish all of my readers a Merry Christmas and a most prosperous New Year! Next year promises to offer some fabulous trading opportunities. But remember, stay disciplined!