10 year Treasury yield Daily Chart Source: Bloomberg, PSR
The bond rout scare has returned to the market as the 10 year Treasury yield flirts with the 3.00% psychological round number. Many analyst and pundits are calling for the end of the 30 years bond bull market if the 3.00% round number breaks to the upside which is partly the reason why the US equity market is also being negatively affected lately.
However, the exact level or threshold that needs to be breached in order to kickstart the bond bear market is the January 2014 high of 3.05%. The recent price action on the 10 year yield has broken above the 3.00% round number but has yet to test the 3.05%. In other words, the bond bull market is still currently intact until we get a daily close above the 3.05% followed by a weekly and monthly close above that level for further confirmation of a monumental trend shift. Keep in mind the bond price moves inversely to the bond yield. Hence, a rising yield represents a falling bond price while a falling yield represents a rising bond price.
Based on our study, a few factors are pointing to the 3.05% to remain intact.
Currently, the market is extremely positioned on the short side of the bond complex especially the 10 year Treasury bonds. Historically, when the net speculator Futures positions exceeded below the –210,000 contracts, short squeezes tend to happen leading to a rise in bond price and a drop in yield. Hence, with the current net speculator Futures positions entering into the extreme short side again at –372,000 contracts, a short squeeze in the 10 year Treasury bond is imminent. That should put a cap on the current bullish momentum with the 3.05% acting as the ceiling.
On the price front, the current picture looks supportive of seeing a near-term top too. With the recent break above the 3.00% psychological round number, the weekly RSI has entered into the overbought condition once again. RSI measures momentum. A reading above 70 represents overbought condition while a reading below 30 represents oversold condition. Historically, going back to 2000, the 10 year yield tends to react spontaneously to an overbought RSI. Whenever the weekly RSI exceeds the 70 overbought condition, a mean reversion lower inevitably happens. Since 2000, there were only five occasions where the 10 year yield entered into the overbought condition. All five occurrences perfectly signalled for near-term tops in yield. On average, the Yield fell -22%.
Therefore, with the recent rise in the 10 year yield leading to the RSI once again being in the overbought condition currently at 70, we expect a mean reversion lower to take place soon. Using the average mean reversion of -22% would translate into a 10 year yield of around 2.35%.
Taking an alternative view on the RSI also reveals another interesting bearish view on the 10 year yield. If the 3.05% resistance area holds, then we could very well be seeing a bearish divergence. In the week ended 16 February 2018 was when the weekly RSI hit a high of 74. Since then, the RSI has formed another Lower Highs (LH) while the 10 year yield continues to establish another Higher High (HH) shown by the diagonal line in the charts. The last time we saw a similar bearish divergence was in 2013 shown by the highlighted box. The 10 year yield topped out at 3.05% in January 2014 after forming a third Higher High (HH) point while the RSI completed the formation of the third Lower High (LH) point. As a result, the 10 year yield fell to a low of 1.64% over the following year.
In summary, with the extremely short positioning in the speculator space and overbought weekly RSI, we expect the 10 year treasury yield to find a near-term top near the 3.05% level with a reversal back below the 3% range.
On the flipside, as long as the 3.05% level holds in the 10 year treasury yield holds, the 200-day moving average in the Dow Jones Industrial Average, S&P 500 index and Nasdaq 100 index should hold too, thus bringing back the risk-on environment.