Going long on US Treasuries with tramline trading

I always make a point of following the US Treasury market. It is crucial in understanding the stock market.

That’s especially so when a consensus surrounds the outlook for long-term interest rates, as is the case now.

In particular, I study the 30-year Treasury bond market (T-bond), as it is less connected to short-term interest rates than shorter-maturity bonds, such as the two-year.

In an ideal world, the yield on the T-bond will reflect the market’s opinion on the outlook for short-term rates plus the ‘inflation’ factor.

Generally, when expectations are for consumer price inflation to accelerate, T-bond yields will rise, and prices will fall. When expectations are for consumer price rises to slow, or even for prices to fall (a very rare event, I must say), T-bond yields will fall, and prices rise.

Long-term rates have been in a severe bear market for many years (in other words, Treasuries have been in a major bull market). The high of 14% came in the early 1980s, when inflation peaked. We saw a spike down to just above 2% in 2009, and are currently in the 4.4% area.

This bull market in T-bond prices reflects the long period of disinflation the US economy has experienced over the last 30 years.

With the recent run-up in commodity prices and money printing via quantitative easing (QE) , most economists and commentators are bearish on T-bonds, believing that the rate of consumer price rises can only go up from here. They expect yields to rise substantially.

What the charts say about T-bonds

But what are the charts telling us?

Here is an hourly chart going back to mid-February showing a rally from the 117 area to a peak at 123.50 on 16 March.

That had to hurt the bond bears!

And look at the rally to that spike top – it occurred between a nice pair of tramlines:

 

(Click on the chart for a larger version)

All trading (except for an ‘overshoot’ at the 16 March top) was contained between the tramlines. Right after the spike top, the market beat a hasty retreat to the lower tramline.

This behaviour is normal after an overshoot. To me, it appears that when we see an overshoot, the upward buying energy has been spent, which paves the way for the selling to take over.

On 17 March, the market broke down through the lower tramline. It was then drawn back to the underside, and then repulsed in a ‘scalded-cat bounce’ (this is pretty self-explanatory, but for more on what I mean by this, you can read my recent post on the topic), as is normal.


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At that point, I drew my third tramline parallel and equidistant below my original lower tramline.

The market sold off and reached this line. It actually overshot it, but then rebounded to trade above the new line.

Again, this is normal behaviour.

But look at the behaviour of the market on 21 March. The market has moved down below my third tramline – and there is a scalded-cat bounce below the line.

Is the market heading lower? Or set to rebound?
But does that mean the market is headed lower?  Not necessarily. We need to examine the move down from the 123.50 high. Here is the 30-minute chart:

 

(Click on the chart for a larger version)

Trading for the three days to 21 March has been contained in my new set of down-sloping tramlines.

Note the ‘overshoot’ was quickly followed up by a rapid move back to the upper tramline.

I have several touch-points (as marked by the green and purple boxes).

The dip to the 120.75 level on 21 March (yellow box) was stopped right on the lower tramline. (Remember, I can draw my tramlines when I have at least two firm points on each line).

All of these points represent possible trading points, of course.

What might happen next?

Now, if the market can push up through the upper tramline at the 121.50 area, that would be a good trading point.

Trading at the moment from the long side has considerable advantages, among which is that the Treasury market has virtually no friends!

There is record (or near-record) bearish sentiment against T-bonds – and for seemingly sound reasons – everyone expects inflation to roar ahead.

But markets have a cunning way of disappointing the majority – eventually!

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