I want to post some work on the bond market, so I thought I would
start with my favorite -- the long Treasury. Inflation has been in a
long term downtrend for around 30 years. So has the long Treasury
yield. Moreover, as investors have gained confidence that inflation
was staying in its downtrend, they have demanded a smaller
premium in yield over the inflation rate as time has passed. To top
it off, the Treasury bond has been a good forecaster of the inflation
trend over time, and as investor confidence in the market has
increased, the bond yield has become less sensitive to shorter term
swings of inflation.
The bull market in Treasury bond prices that has accompanied the
long run downtrend of yield has been one of the great fixed income
bulls of all time. And, since inflation pressure has subsided by such a
large margin over the years, it would be flippant simply to proclaim
the demise of the bull.
Over the 1988-98 period, the premium in the yield of the long Treas.
over the CPI (yr / yr) ranged primarily between 300 - 500 basis
points (3% - 5%). Since then, the premium has eroded to a range of
200 - 250 bp when monthly extremes of inflation / deflation
readings are X'd out. When I use a constant 3% inflation rate, the
range in premium is 130 - 230 bp excluding the outliers.
Short term changes to the inflation rate have heavily reflected the
swings in the commodities market over the past 10 years, most
notably oil, petrol and natural gas. So, in looking at the Treasury
market, I have grown more comfortable with the idea of a constant
3% inflation assumption. On this basis, the 30 yr. Treas. -- now
4.55% -- should yield between 4.30 - 5.30%. Since the present
yield is at the lower end of the range, I conclude inflation
expectations are subdued.
On a short term basis, the Treas. bond yield is most sensitive to an
index of the momentum of the $ value of sensitive materials
production. When the economy went into free fall starting in mid-
'08, that index stood at 117.9. It plummeted to an extraordinary low
level of 40.0 by 1/09. It has since shot back up to about 130. The
bond yield followed the same "V" pattern as you know. Since the
heavy industry momentum index is now at an unusually high level,
I suspect the upward thrust on the Treasury yield has seen its peak
in the short run.
I do not see much reason for upward pressure on the long Treas.
yield in the short term. However, as the economic recovery persists,
there will be a couple of more upswings in sensitive materials prices.
On top of that, the Fed will eventually push up short rates, and
broader cyclical pressure will lead to more acceleration of inflation
pressure. So, over the next 12 mos. it seems reasonable to expect
a cyclical rise in the long Treas. yield up toward 5.25 - 5.50%.
From a technical perspective, the bond market now has a slight
downward tilt to yield when measured by 26 wk. momentum.
It is neutrally priced against the 40 wk. yield m/a. 30 Yr. Chart.
Since I like to trade extreme readings above / below the 40 wk. m/a,
the bond is not interesting now.
- Peter Richardson
- Retired chief investment officer and former NYSE firm partner with 50 plus years experience in field as analyst / economist, portfolio manager / trader, and CIO who has superb track record with multi $billion equities and fixed income portfolios. Advanced degrees, CFA. Having done much professional writing as a young guy, I now have a cryptic style. 40 years down on and around The Street confirms: CAVEAT EMPTOR IN SPADES !!!