On The Move to Higher Rates

Investors and general market watchers are being inundated with comment, views, hopes and fears in respect of the American “Fiscal Cliff,” set to kick in at year’s end. You may be pleased to know that we will not add to this comment. At least not this week.

What we will comment on is the likely trend for long-term US interest rates, the ones that affect everyone’s borrowing costs, such as the 30 year Treasury bond.

Although the outcome of the fiscal cliff will no doubt be given credit for what the future holds for the 30-year treasury, in reality the answer lays in the charts.

First up we show a long term chart of the 30-year yield and as can be seen it’s been one heck of a bull market, with yields falling from 16% pa back in 1981 to the current 2.75% level.

Could they fall further? Of course, but the odds are slipping. The actual low of the whole period was in June of this year, when the yield touched 2.45%, a 35 year low, since when the yield has trended higher within the mini blue trend channel. Incidentally, the 10-year treasury yield touched a 220 year low at the same time.

We also like to study volatility and for the 30-year, Merrill Lynch kindly devised an index called the, “Merrill Option Volatility Estimate,” better known as the MOVE Index.

So next up we show the 30-year price compared with the move index, albeit that the move was only introduced in 1988.

The treasury price is the opposite of the yield, as yields fall the price rises and vice versa if the yield rise, price falls.

One can note from both charts that over the past five years, since the onset of the financial crisis, yields have plummeted whilst the price has jumped, as investors flocked to the perceivedsafe haven” of sovereign debt. (Lending to the Government as governments never default??)

At the same time volatility (MOVE) has collapsed. In fact it’s at a 5 year low and an all time low.

For the uninitiated, when volatility of any security hits an all time low, the odds increase substantially that it is about to pick up and likely pick up with a vengeance. Furthermore, as volatility returns, the direction of price is unlikely to take the same direction as the late 1990s and post 2007 shown above.


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