Bond yields to rise as bull wanes

By Walter J. Burke

Walter J. Burke is a chartered market technician and senior technical analyst with MCM MoneyWatch in New York.

The original outlook for bonds during 2000 suggested the probability for a large decline in Treasury bond yields to correct the bearish excesses that formed during the October 1998 to January 2000 bear market. This bear advanced T-bond yields from a low of 4.69% to 6.75%, making its effect historically vicious. (This view for a substantial yield rally was presented in "Secular bull rally in store for T-bond yields," Futures April 2000 issue.) With this correction completed, odds favor a renewed rise in yields in 2001.

As a review, bond yields declined (bond prices rallied) in a three step Elliott Wave ABC-type pattern from the January 2000 peak. Significance was placed on the likelihood of a 50% to 62% retracement of the run-up from 4.69% to 6.75%. Such a correction would imply a target of 5.47% to 5.72%.

T-bond yields did decline from the January peak to the April low at 5.64%, which was wave A. Yields then rose in a wave B to the May peak at 6.24%. Wave C followed into September when yields bottomed at 5.63%. From the January yield peak and throughout most of 2000, investor sentiment as measured by the four-week moving average of Market Vane's bullish consensus rose from a depressed 16% (most bearish in at least 20 years) to an extremely bullish 72%. This was the highest level since the 79% reading recorded in October 1998 when yields were at 4.69%. Because this is used as a contrary indicator - that is, when the majority currently is bullish, future market drops are expected - the 2000 yield decline accomplished its mission of relieving the extreme generated during the 1998-2000 bear market. This now leaves the market vulnerable to a disappointment.

Evidence also was increasing that the secular decline in T-bond yields from the 1981 peak was completed and that yields were in a transition phase to a secular sideways or rising trend. This remains the case. The secular downtrend in yields was broken by the 1998-2000 bear market. All the 2000 bull could do was to retest the trendline. Additionally, as part of this transition phase it seemed likely that a significant retracement of the 1998 yield low would occur < much like the 1984 deep retracement of the 1981 yield peak. This too has occurred.

There even is a possible head and shoulders bottom in yields that has been forming for the past several years. The late 1995 yield low at 5.92% was the left shoulder, the 1998 low at 4.69% the head and the 2000 low at 5.62% the possibly completed right shoulder. An advance above the pattern's neckline at 6.65% will complete it and project a further yield rise toward 8.92% < height of head and shoulders pattern (227 basis points) added to the neckline < as a longer-term target, which may not be achieved in 2001. Supporting the idea of an important shift in the outlook for T-bond yields are the long-term momentum models, which have bottomed and are in the process of reversing.

The pattern from the January yield peak also can be interpreted as a bearish falling wedge pattern. Of immediate (during the first quarter of 2001) concern is the completion of this pattern. A rise above 5.92% will accomplish this. A characteristic of a wedge pattern is that once completed prices tend to move quickly to where the pattern began. In this case, that is to the May peak at 6.24%. A move through that level would then complete a double bottom (April low at 5.64% and the September low at 5.62%) and project a further rise toward the measured objective at 6.90%. This easily would carry yields above the head and shoulders neckline, which completes that pattern.

Until the wedge is completed, T-bond yields could continue to churn around the 5.62% low and possibly extend to the lower retracement level at 5.47%. For 2001 and the next few years, however, the likelihood is tilted in favor of rising yields.