Tuesday, July 2, 2013

Inflation’s shot across the bow

On May 3, the bond market fired the proverbial “shot heard ‘round the world.”  Treasury yields began a two-month climb to levels not seen in almost two years.  Many analysts proclaimed the end of the 30+ year interest rate decline.   The true significance in the yield rally isn’t that the long-wave deflationary trend in interest rates is over, however.  Rather, it’s that the commencement of long-term inflation is within sight.

While the rally in Treasury yields does have longer-term significance, it’s still far too early to assume the downtrend in yields is over.  As we’re still some 15 months away from the bottom of the 120-year cycle of inflation/deflation we can only assume the downward trend in interest rates remains intact.  Additionally, as real estate analyst Robert Campbell has pointed out, “until the actions of the Fed speak otherwise, Fed policy is currently working to push mortgage rates down.”

The rally in Treasury yields, while impressive, should be put into context with the longer-term yield trend.  Here’s what the Treasury Yield Index (TNX) looks like from the vantage point of a 2-year chart.  In this relative short-term chart you can clearly see the attempt yields have made in establishing a new rising trend in relation to the steep drop in 2011-2012. 

It’s only when we examine the long-term monthly chart of TNX that the true long-term trend becomes clear.  The downtrend line that can be drawn by connecting the yield peaks from 1996 through 2011 hasn’t even been broken yet.  The interest rate downtrend is therefore presumed to be still in force.  It likely won’t be until after October 2014, when the Kress mega cycle bottoms, that we’ll finally see this downtrend broken.

What then is the ultimate significance of the sharp rally in bond yields?  The spike in yields can only be appreciated by making historical comparisons with markets that behaved in a similar fashion.  For instance, gold was in a similar long-term downtrend from 1981 through 1999 when, in the autumn of ’99, the yellow metal unexpectedly launched a vigorous rally from its long-term low of nearly $250/oz. to a high of over $330/oz. in just a few short weeks (see chart below).  This wasn’t the official beginning of gold’s long-term bull market, which would actually begin less than two years later.  It was, however, an advance warning that a major change of gold’s long-term trend was in the making. 

Comparing gold with bonds isn’t as dissimilar as some may think, for both are excellent barometers of longer-term global liquidity and inflation/deflation expectations.  Of the two, interest rates are a more important indicator of inflation and deflation, so it will be especially important to monitory the interest rate trend in the coming months as we draw closer to the 120-year cycle bottom.

The ultimate meaning behind the short-term rally in Treasury yields can only be known with certainty after the facts have become clear.  It’s still far too early to discern what those facts may be.  Based on historical examples, however, it’s probable that the yield rally is a “shot across the bow” preliminary to the beginning of a new long-term inflationary trend starting in late 2014/early 2015.  

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