T-bonds and Chinese stocks: we’re spoilt for choice

published 29 July 2015

Later today, the Fed will be announcing the minutes of their latest monthly deliberations and the markets are all agog. Will they or won't they? The future of all mankind hangs on what they intend to do with their Fed Funds interest rate target (or so the mediawould have you believe).

Yes, preposterous as it is, many pundits are worried sick, fearing trouble in the stockmarkets if the Fed announces a rise of wait for it 0.25%. For those born before the year 2000, a move of this minuscule amount will seem no more than a blip and of no measurable consequence on whether anyone will decide against taking a loan in the real economy.

But I have news for those pundits: the market has already decided it for them.

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Here is the latest chart of the interest rate on three-month US Treasury T-bills:

The floor has been 0.0100% and in the past two weeks, the rate has shot up to 0.0500% a massive increase of 500%! That is a solid vote for higher short-term interest rates.

So anyone paying attention to the real world of open market honest price-discovery (rather than the fairyland of Fed manipulated rates) can now rest easy and spare us their convoluted articles. They have their answer.

But what is curious to me is the behaviour of the long-dated 30-year T-bonds. The yield on these is also determined from honest, open market price-discovery and this is the chart:

Remember, the price of the bond moves inversely to the yield. So when the price shot up from mid-July, the yield was falling. But at the same time, the T-bill yield was rising. That is an unusual event. The yield spread was thus in decline the yield curve was getting flatter. And that was a stark reminder that the economy is in a deflationary phase.

When long-term rates decline, investors are willing to pay up for the bonds as their inflation expectations are weakening. They judge that they do not need so much yield to compensate for future inflation. The market is saying that it does not expect to see an increase in inflation; rather, dis-inflation and even deflation.

Incidentally, the 30-year Treasury is one of my all-time favourite trading markets to swing trade. At mid-month, sentiment had reached an extreme in bearishness (most pundits expected the Fed to raise rates which 'should' knock the bonds). But I spotted an opportunity and went long against conventional wisdom. Now, the market has moved up in a C wave to where the C wave equals the A wave in height and provided a good place to take partial profits of around 550 pips.

Another trading opportunity on the other side of the world

Elliott wave

The rally off the wave 1 low is an A-B-C affair (green lines), which is typical of second waves. Now the market is embarking on a third wave down, which promises to be long and strong. When the market breaks below the 200-day moving average (MA red line), the selling will become intense.

That Chinese bubble has now burst. And faith in the authorities to keep the bubble inflated will evaporate as the market works lower. They will come to realise that no matter how much 'support' the authorities offer, it will do no good if the will to invest/gamble isn't there. It is called pushing on a string.

The power of fear trumps everything else. Many investors/gamblers will be ruined and who knows the consequences for social order in China.

On the eve of the Fed announcement, markets are braced but I expect them to become very lively as the news filters out. We often see very wide swings both up and down immediately after a widely-anticipated news release and I have no reason to expect otherwise today.

John is is a British-born lapsed PhD physicist, who previously worked for Nasa on the Mars exploration team. He is a former commodity trading advisor with the US Commodities Futures Trading Commission, and worked in a boutique futures house in California in the 1980s.

He was a partner in one of the first futures newsletter advisory services, based in Washington DC, specialising in pork bellies and currencies. John is primarily a chart-reading trader, having cut his trading teeth in the days before PCs.

As well as his work in the financial world, he has launched, run and sold several 'real' businesses producing 'real' products.