Thursday, December 16, 2010
All of a sudden, everyone is talking about higher interest rates.
It's the most popular topic on many financial blogs. The talking heads on CNBC have been squawking nonstop about it for the past two days. I even overheard a couple golfers talking about it on the driving range yesterday.
What a difference a few weeks makes.
Two weeks ago, nobody cared that interest rates were rising. Two months ago, the entire world seemed convinced the Fed could push long-term interest rates even lower. But we thought differently, and we talked about it here, here, and here. It was a classic contrarian argument. If you joined us and bet on an increase in long-term interest rates, you've turned a tidy profit.
Now, however, betting on higher interest rates is no longer a contrarian trade. It's downright mainstream.
So while I'm flattered the rest of the world has come over to our way of thinking, I'm worried the "higher interest rate" trade has become too crowded too fast. All the bond market bears are huddled on one side of the boat. The odds are good the market will do something to toss them overboard.
Please don't get me wrong. The 30-year bull market in bonds is over, and interest rates are going higher over time. There's no doubt about it.
We've seen a dramatic increase, however, in just the past two months. So the market is due for a short-term, counter-trend move.
Here's an updated chart of the 30-year Treasury yield...
The red lines on the chart represent various support and resistance levels. They're good price targets for moves on the way up, and they provide support (and good trade-entry levels) for moves on the way down.
The numbers on the chart annotate the short-term price moves, or "waves," within the chart pattern.
Without getting too complicated... when a chart reverses from a bear market to a bull market pattern, it does so with a five-wave move. In other words, there's a series of higher highs and higher lows that unfold in five distinct moves as illustrated on this chart.
So there's no doubt interest rates are now in a long-term bull market and are headed higher over time.
However, the initial five-wave pattern is now nearing completion. Following this, markets typically correct in a three-wave move lower before resuming the uptrend. Given the sudden and tremendous shift in bearish bond sentiment, the timing seems just about right for the start of that three-wave correction.
If you'll allow me to gaze into my crystal ball for a moment, here's what I see happening...
The first move lower in rates should find support at 4.3% (43 on the chart) and bounce slightly higher to complete the second wave. The third and final move could push long-term rates down to 4.1%. That was a key breakout level in November as rates were moving higher. It should be strong support for any correction.
If you've profited off the move higher in interest rates so far, congratulations. Now it's time to take some profits off the table. Look for a move back down to 4.3% or 4.1% as an opportunity to jump back into the trade.
Best regards and good trading,
Jeff has been calling the rise of long-term interest rates over the last few months. And as he notes, you'd have turned a handsome profit if you followed his advice. Watch how these trades played out over the last few months here, here, and here.
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