by Kevin Klombies, Senior Analyst

Monday, August 20, 2007

Chart Presentation: Treasury Trend

Friday was obviously a volatile session with the Fed cutting the discount rate (but not the funds rate) by 50 basis points. The equity markets surged, the U.S. dollar declined, and long-term Treasury prices moved lower.

Much of our work has been focused on what has to happen before the Fed will cut the funds rate and what happens afterwards. Since the Fed has yet to cut the funds rate it is, in a sense, business as usual.

In uncertain times we typically shift to more macro perspectives. With equity, bond, and forex prices making huge intraday swings we prefer to take a longer-term view than, say, lunch.

The four charts of the U.S. 30-year T-Bond futures. The chart shows 2004, the second chart is 2005 (scaled upside down), the third is from 2006, and the last or bottom chart is from 2007.

We argued weeks ago that over the past three years the bond market has followed a very similar path. Note that the 2005 example is scaled upside down but for the sake of simplicity we are going to refer to prices move ‘up’ or ‘down’ in terms of the visual representation shown in this presentation. Bond prices started out in March near a peak, declined through the second quarter only to pivot upwards at the end of June.

We commented (more comment than argument) that if history were to repeat that the TBond futures should rise to or just above the 200-day e.m.a. line by the first week in August (i.e. 110- 111). Strangely enough that is exactly what the TBonds ended up doing.

We have stacked the four charts to take this argument one step further. If the TBonds are following a general trend or pattern by spiking up through the 200-day e.m.a. .in August then the charts also suggest that the TBond futures should be somewhere between 113 and 114 by November.

The rather simple point is that even if the TBonds get hammered back towards 106 later this month (similar to the 2005 chart) bond prices look higher towards the end of the year. To us this suggests that through the balance of the year risk is more heavily skewed towards cyclical weakness instead of surprising cyclical strength and mounting inflationary pressures.





Equity/Bond Markets

Our point was that bond prices look higher through the balance of the year which suggests that those sectors that have been putting pressure on bond prices- notably the commodity markets- should continue to resolve lower.

The chart compares crude oil futures, Bear Stearns (BSX), and Microsoft (MSFT).

Much of the pressure on the equity markets has occurred since June so the charts suggest that the problem lies in part with the upside break out by crude oil futures through the March to May peak around 67. In other words notice that both BSX and MSFT were holding fairly positive trends until oil prices turned upwards in May and then broke to new highs in mid-June.

The point is that while the equity markets rallied rather sharply on Friday’s Fed news at minimum we will need to see crude oil futures prices break below the rising support line at 70 and then ideally move back below the 200-day e.m.a. line closer to 66 before we can truly argue (with any conviction) that the correction has run its course.

The chart below shows Mitsubishi UFJ (MTU), Genentech (DNA), and Alaska Airlines (ALK). While BSX and MSFT turned lower on the final rise for crude oil prices in June these three stocks turned to the down side at the start of the year as oil prices moved up from the January lows. There are stocks and sectors that can easily rise from current levels but only if the market’s reaction to Fed easing is not renewed strength in the rising trend for energy prices.

Below is a chart at that we have shown on a few occasions in the past. The idea was that in both May of 1996 and May of 2006 the ratio of commodity prices (CRB Index) to the dollar (DXY) reached a peak while Intel was at a bottom. If the trend is similar to 1996- 1998 then commodity prices should continue to decline, the dollar should rise, and the stock of Intel would then be expected to continue to resolve upwards.