US Treasury Rates Soaring—Not a Good Sign

The S&P500 slumped over 2% last week, recording one of its largest weekly losses of 2013. The volatility index, or VIX, increased only slightly. And volume was not very strong. Both of these points suggest that the sell-off, while meaningful from a percentage standpoint, was not rooted by panic selling where investors were rushing to get out of the stock market.

Technically, especially beneath the surface as expressed by breadth signals, things are looking more bearish. Momentum to the upside has clearly ebbed, on the daily charts. But upward momentum has not turned down on the weekly charts. In terms of breadth, new lows are now greater than new highs, and this indicator looks like it’s going to get even worse over the next several weeks. Also, the percent of stocks above the 50 day moving average has turned down decisively. This is also a bad sign.

On the surface, the stock market has not sold off all that much. Despite the recent price weakness, prices are still not that far away from their all-time highs. But beneath the surface, the breadth indicators are turning bearish, and this is often a precursor to a much more severe price sell-off, one that would turn the more important weekly price and momentum indicators down also into bearish mode.

The US economy, meanwhile, is limping along as usual. The headline retail sales report missed expectations. So did business inventories. Producer prices came in lower than projected; consumer prices met expectations. The Empire State manufacturing survey also missed expectations. And the Philly Fed survey badly missed. Industrial production, at 0.0% was well below estimates. Housing starts missed. But the biggest miss of the week was consumer sentiment—instead of rising slightly as expected, it collapsed, notching its biggest miss on record….going back to 1999 when it was first introduced. Clearly, the US economy, now over four years after beginning it’s so-called ‘recovery’ is nowhere near to truly recovering.

Several months ago, we noted the burgeoning development in the US Treasury markets—namely that interest rates were beginning to rise—and that this could be the precursor to other negative market movements. Well now, over two months later, US Treasuries have sold off even more. The 10 year rate is now approaching 3%, when about a year ago it was under 1.5%.

As mentioned in the earlier post, rising rates—when inflation is largely steady—means that REAL interest rates are rising. This leads to several negative consequences. Corporations will reduce investment in capital expenditures, which will lead to lower growth and lower profits. Corporations will have to pay more to borrow on their existing debts, which will lead to lower profits. Consumers will have to pay more to borrow  for everything—homes, cars, credit purchases—which will also lead to lower corporate sales and profits. Finally, investors will be more enticed to pull money out of stocks,  because they will be able to earn fatter returns, at lower risk, by buying US Treasuries; this leads to a greater risk of a severe correction in the stock market.

US Treasuries are not, by any means, rising for the typical good reason—the economy is booming and rates must rise to reflect the good times.

So while the warning a few months ago was tentative, the warning today is becoming louder and more serious. Not only have rates risen substantially recently, they look like they could rise even more.

If so, be prepared for a major risk-off moment, or two, when ironically, if stocks were to sell-off, money could flow out of stocks and back into Treasuries driving the yields back down.

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