Why Treasury yields might be closer to breaking down than breaking out

Key Takeaways
  • SPX likely to bottom by Friday/Monday and turn back up to 4500
  • Treasury yields look close to stalling out, and rolling over
  • Correlation has gotten quite compressed; Yet no evidence of meaningful reversal
Why Treasury yields might be closer to breaking down than breaking out

Trend bullish – Expect this two-day pullback will not break initial support at 4384 before pushing higher to exceed 4458 on its way to 4500 before any real stallout occurs. 

It remains difficult to have any conviction that this market might be turning down.  Looking at Thursday’s session, the minor weakness held almost exactly where it needed to before stabilizing and attempting to push higher into the close. 

The one minor change over the last couple days has been the pickup in correlation from very low levels.  In the minor pullbacks in Mid-June and May, there seemed to be sector rotation that balanced the market decline, while this week we’ve seen more evidence of all sectors falling in unison.  Additionally, European and Asian indices are witnessing similar selloffs but at a greater magnitude than the US.

For now, insufficient technical damage has occurred to make much of this two-day weakness. Furthermore, Large-cap technology proved to be a savior for stock indices yet again, as XLK 0.13% ’s -0.37% decline outperformed both REITS and Utilities.

While markets have had a minor defensive tone this week, a few days of defensive strength doesn’t stack up against nearly seven weeks of underperformance.  Thus, it’s still tough to argue that US sector performance is demonstrating much proof of a flight to safety.

As mentioned last week, the typical warning signs that normally accompany market selloffs are still lacking.  Until there’s evidence of sentiment getting more optimistic coupled with counter-trend DeMark-based exhaustion forming on leading Tech stocks like AAPL -1.10%  or MSFT -0.45% , it’s going to be right to respect this current trend, no matter how overbought some might claim market momentum has become.

Furthermore, wave structure and cycles still point higher and time periods for concern don’t really materialize until late July.

Outside of Equities, the surge in Treasury yields given the recent resilience in US economic data proved to be the most interesting technical development.  Overall, the rapid rally in Treasury yields on a recent spike in hawkishness doesn’t look to extend much more, and looks close to reversing back to the downside.

In summary, short-term bullish Equity trends coupled with weekly momentum remain positively sloped, and should bring about rallies into mid-July.  What’s needed to change this thinking?  A decline under late June lows at 4328 would argue this thesis is wrong, and would bring about a retest of the green uptrend line shown below.  Until that occurs, it’s right to lean long and expect 4500 could be in play.

Why Treasury yields might be closer to breaking down than breaking out
Source: Trading View

Treasury Yields might stall out and break down before they break out

Yields have pushed back up to near former March highs across the curve, as 2’s, 5’s, 10’s and 30-year Treasury yields all tested this key level.

(Earlier in Thursday’s session, both 2-Year and 5-year yields looked close to breaking out, but failed and reversed course by end of day).

Three factors support the notion that yields likely are closer to breaking down instead of breaking out: 

  • Counter-trend DeMark based exhaustion is now present on TLT
  • Cycles point lower for Treasury yields in the months ahead
  • Elliott-wave structure suggests that this recent run-up in yields is close to reversing

A fourth possible reason might involve the degree of hawkishness that has swept over markets in recent weeks, with a 25 bps rate hike now being priced at a more than 90% chance for late July.

As charts below show, yields have pressed up rapidly to near former highs, but have not broken out above March peaks.  There should be ample resistance to this runup in yields that causes rates to stall out in the days to come and should cause the next big move in rates to be “down” not “up”.

This sudden positive correlation between Equities and Treasuries has been somewhat rare, as the entire Treasury selloff since May has coincided with Equity rallies, not selloffs.  If this were to continue, then a lower than expected result in Friday’s Non-Farm Payrolls could cause a reversal back lower in yields, which would be greeted by an Equity rally back to monthly highs.

Overall, TLT, IEF 0.45%  look attractive at current levels and I expect these are close to bottoming out.  I expect lower yields in the weeks and months to come, not a continuation higher.

Why Treasury yields might be closer to breaking down than breaking out
Source:  Trading View

US outperformance over Europe looks to continue into mid-to-late July

US still looks early to show mean reversion vs. Europe after two steady months of outperformance.  Thursday’s sharp decline in Europe was not followed by much of a reaction in US Equities, and that led the ratio of SPY 0.25%  to FEZ 0.31%  (SPDR S&P 500 ETF Trust vs. SPDR EuroSTOXX 50 ETF) to break out and accelerate even higher.

Technically, this outperformance of US vs. Europe looks to continue a bit longer.  My own interpretation of SPY/FEZ, when overlaying DeMark based indicators, seems to suggest another two weeks of possible outperformance before this finds time-based resistance.

Thus, this recent uptrend should continue higher and SPY should outperform FEZ into mid-to-late July.

Why Treasury yields might be closer to breaking down than breaking out
Source:  Symbolik

Correlation has started to lift from very low levels

The CBOE 1-month implied correlation index has finally started to turn mildly higher this week after reaching extremely low levels.

The current reading of 14.92 has risen from 12.5 but formerly peaked out near 55 back in October 2022. 

It’s not wrong to say that current market conditions remain favorable towards “Stock pickers” given such low correlation.  However, if/when this begins to rise back over 25, technical trends would suggest a further increase in correlation.

Normally, stock market declines can result in correlations starting to rise, and so reaching very depressed levels which were last seen in late 2021 is worth noting.

However, at present, there remains insufficient grounds towards saying that Correlation is headed much higher in the short run.  In my technical view, this requires a further gain back over 25.

The weekly CBOE 1-month implied correlation index (COR1M-Bloomberg) is shown below.

Why Treasury yields might be closer to breaking down than breaking out
Source: Bloomberg
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