The temporary fiscal cliff “resolution” started the new year off with a big rally in equities Wednesday, sending the S&P 500 to its best levels since mid-October and just 12 points below its 2012 high. Bonds, on the other hand, took a beating, rising to a yield of 1.845% as a result — and they look vulnerable for further weakness ahead.
For right now, though, let’s look at bonds in terms of price for simplicity’s (and trading’s) sake.
From a longer-term perspective, bonds remain in a mighty uptrend. The 10-year Treasury bond futures price (noted in the chart below) remains in a solid uptrend, so in my opinion, it’s too early to call for the end of the bull market. However, if you hone in on the nearer-term, things look a lot different.
Using the iShares Barclays 20+ Year Treasury Bond ETF (NYSE:TLT) — a basic proxy and trading vehicle for the 10-year note, though it does have a different duration (in case you care) — there are two basic support levels of note: the March 2012 lows near $109 and the September 2012 lows near $118. (To be clear, the way I use these simplistic support lines is for reference levels rather than defined hard stops or targets. Reference levels work well in current times where markets are controlled by central banks and news bits strategically placed by politicians.)
The September 2012 support level near $118 is only 1.5 points, or 1.25%, away from/lower than yesterday’s closing price. More importantly, however, note the series of lower highs since the late-July top. With four lower highs in place, the odds favor a lower low to arrive sooner rather than later. A lower low here would mean the TLT has a daily close below $118.
The $118 support level also happens to coincide with the 61.8% Fibonacci retracement level of the March-July rally. If and when this level gets broken, price should have enough momentum to slide closer to the $114.50 area.
Given the current structural environment of risk-on/risk-off phases, the high correlation among asset classes needs to be considered when looking at bonds. In the case of bonds — and the TLT — the inverse correlation between stocks and bonds right now must be kept in mind. As long as central bank interference remains high, bonds should be better-bid during equity selloffs and vice versa. So, if equities continue to run higher into deeper January, bonds have a good chance of continuing their slide, and the TLT could reach the $114.50 area.