The S&P500 climbed 3.1% last week, in a continuation of the rebound from the late January lows. But the volume pattern was still bearish–in weeks when equity prices fell this year, volumes spiked; in the last two weeks when prices rose, volume dried up. The VIX (or fear) index fell, but stayed well above its lows from early January.
The economic data were mixed. The Empire State Mfg survey was better than expected. Housing starts rose more than expected. Producer prices were higher than estimated; consumer prices were lower. But the downside risk of dropping consumer prices is the threat of deflation; so lower consumer price appreciation is good, but the markets would fear negative price trends. Initial claims jumped more than expected. Leading indicators rose, but less than economists had projected. And the Philly Fed survey came in slightly better than forecast.
Technically, the S&P’s multi-month uptrend is still broken on the weekly charts. The daily charts show that the strong bounce from the February 5 lows could be nearing its completion, especially when the paltry volumes do not validate the price rise.
Since 1982, when the Fed chairman, Paul Volcker, shoved interest rates up to break the back of inflation, the U.S. Treasury bonds have enjoyed a secular bull market–rates have trended down, as bond prices have trended up.
After 30 bond rates dropped to 2.5% in December 2008, they have been crawling up, reaching 4.7% last week. Over the last 28 years, one or even two percentage point variations–within a year or two–have been perfectly normal because the rate rises never broke the long-term downtrend.
Until now. The 28 year old trendline is about to be tested. If 30 year Treasury rates rise above 4.8% to 4.9%, then most technical analysts will begin to call for the end of this monster rally. And traders could respond to such analysis by selling long-term Treasuries, pushing rates up even higher, thereby making the rate increase more decisive.
Fundamentally, the long-term rates are in a major tug-of-war. On the higher rate side, concerns about rising inflation, enormous debt supply and even growing credit risk (credit default swaps on U.S. sovereign debt have risen in price over the last several months) will tend to push prices down and rates up.
On the lower rate side, the risks of deflation and a double-dip recession will tend to apply downward pressure on rates and upward pressure on prices. Also, the strong possibility of an international (non-U.S.) financial crisis, in Greece, other European nations or even Japan, would shove rates lower as capital from the affected regions would rush into the relative safety of U.S. Treasuries.
In the end, the actual rates will tell us which side will win this battle. And chances are high, as in an actual tug-of-war, that one side could take control for a while, and later the other side could take control also for a while. In this scenario, we’d enter a long-term trading range (as we did from 1890-1910 and 1940-1950) where rates oscillate in a narrow horizontal band. The long-term downtrend would still be broken, but a new uptrend need not begin right away.
Either way, we are at a major testing point for the 28 year old downtrend. Very soon, perhaps within one or two months, we will know if it has finally ended.