Steady decline in yields is a bullish sign for bond markets

The Insider

Your Money

June 12, 2005|By BILL BARNHART

AFTER encouraging rallies last month, the stock and bond markets have stalled.

Major stock indexes remain in negative territory for 2005. Forecasts of second-quarter corporate profits are bland. Trading activity appears to be in the summer doldrums.

All eyes on Wall Street have shifted from stock prices to interest rates. This is alien territory for most individual investors, but here's a tip: We're all bond traders now.

Home-buying is the critical element. The outlook for long-term interest rates, which determine home mortgages, is the bottom line of the investment picture.

Even Federal Reserve chief Alan Greenspan can't explain the trend in long-term rates, as expressed in yields on 10- and 30-year Treasury bonds. Bond yields have dropped steadily during the past 12 months even though the Fed has tripled short-term rates.

The history of bond trading in the Chicago futures markets offers an important insight. The motto on LaSalle Street, home of the Chicago Board of Trade, is, "The trend is your friend."

"We're in the midst of a 20-year bull market in bonds," said John Kosar of Asbury Research. His firm relies on analysis of price trends in stocks, bonds, currencies and commodities.

"Once a trend is in place, you expect it to continue in place until there is hard evidence that it isn't valid anymore," he said. "There is no indication that the trend is over. Who's smart enough to say this trend is going to stop here?"

Does that mean you should wait to lock in your next mortgage rate? Not necessarily. Kosar's charts tell him long-term rates are likely to bounce higher for a while, as they did Friday.

The 10-year Treasury yield climbed above 4 percent for the first time this month. "We're at a near-term inflection point," he said. "It could last a few weeks."

Kosar notes three factors:

Sentiment indicators, especially excessive optimism among retail bond market investors, suggest that bond prices will fall and yields will rise.

Open interest in the Treasury bond futures market, which measures futures contracts not closed overnight, has been declining, even though rates have fallen in recent weeks.

When open interest declines as bond yields rise, the denizens of LaSalle Street see lower prices and higher yields ahead.

Charts of historical Treasury prices, such as the 30-year bond and the five-year note, indicate that the recent rally probably will reverse for a while. The pattern has occurred twice since June 2003.

"Obviously, rates are very low, and it's hard to make a logical argument that they are going to keep going down," Kosar said. "But that's like standing in the middle of the street with a truck heading at you and betting that it's going to stop just before it hits you."

Ouch.

Bill Barnhart is a columnist for The Chicago Tribune, a Tribune Publishing newspaper. E-mail him at yourmoney@tribune.com.

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