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Financial Industry Insights from Advisors Asset Management

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My Prerogative: Are 10-Year Treasury Rates Poised to Climb Higher?


For the past several months we have been discussing the technical factors that are helping contain 10-Year U.S. Treasury (UST) rates. The yield on the benchmark security has risen significantly from the July 2016 low of 1.35%. After peaking at 3.12% in May of this year, it sharply corrected by 37 basis points to 2.75%. Since that time, however, it has remained in a holding pattern bounded by 2.82% and 3.02%.

The below chart provides analysis to explain that the tide may be getting ready to turn. We may be preparing ourselves to either change our mind (per our prerogative); or be proven wrong if we remain steadfast regarding our assertion that interest rates have already peaked for 2018 and will remain subdued for the foreseeable future. We have not suggested in past commentaries that, from a longer-term perspective, interest rates will remain low. We agree that the long-term trend is for higher rates. The only challenge we have been proposing is the timing of such a move.

The ascending interest rate channel from July 2016 is illustrated with the parallel white lines. Rates are contained in the lower-half of this channel, but clearly following an upward trajectory. The yellow line demonstrates that there is still plenty of upside room above the top trend line connecting the December 2016 and aforementioned May 2018 high.

Source: Bloomberg

Within the past few days, if the pennant pattern (as illustrated with the narrowing green lines) is valid, 10-Yr UST rates appear to have broken out to the upside – a bearish event for rates. The red almost-flat line highlights the upper-support area which rates have rejected several times already and is currently containing yields for the time being.

The below chart highlights a textbook head-and-shoulders pattern that had been developing for much of the year. Until a few weeks ago, interest rates appeared to be holding this bullish pattern. If yields have in fact rejected the completion of this pattern, the argument for rates staying low begins to no longer hold water.

Source: Bloomberg

The Fed appears to be on-track to follow through on two more rate hikes this year. Though these should largely affect the front-end of the curve. The pending September hike is basically priced into the market. Fed policy action could invert the already flat yield curve if there is no give on the belly and long-end of the market. The 2’s-10’s spread is presently at 21 basis points. So, a sharp move upwards of 25 basis points will cause an inversion if 10-year yields do not move higher. As an aside, we do expect the Treasury curve to invert before it steepens.

The domestic economy remains robust, normally providing the bond market with impetus to higher rates. Further, the markets seem to be more resilient and less reactive to President Trump policy and tweets that could cause a hiccup in economic growth expectations and create a flight-to-quality trade in the Treasury market.

In summary, we are not quite ready to abandon our assertion that rates will remain contained. The argument for higher yields in the foreseeable future, however, is getting some strong support from technical indicators and traditional economic analysis. The 3.12% area remains a very important technical support area that was last observed in July 2011 – over seven years ago. The next major support above there is around the 3.55-3.58% range, with some minor support slightly lower. If this last bastion of support around 3.12% is penetrated, rates could reach 3.50% before year-end. Just like Bobby Brown, we reserve the right to change our mind should this occur; it’s our prerogative.

 

CRN: 2018- 0907-6886R

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at commentary-disclosures. For additional commentary or financial resources, please visit www.aamlive.com.

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Effective, June 10, 2016, please note that Gene Peroni left Advisors Asset Management (AAM) to become President of Peroni Portfolio Advisors, Inc. Peroni Portfolio Advisors, Inc. ("PPA") is an investment advisor independent of AAM.

 

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