Technical Thursdays: Rates Matter

As the chart to your left shows quite clearly, when the 10-year Treasury recently broke out of its multi-year downtrend, the move was more dramatic than your standard upward blip. In fact, I am fairly certain that most market technicians would argue that the breakout was more than a mere coincidence as the sharp upward move occurred right at that multi-year downtrend line and after an extensive multi-year base building process.

So, what are fundamentally oriented investors to make of this?

The fundamental connection lies in the attempts of central bankers to address the issue of excess global liquidity. As central banks do their best to drain excess liquidity without precipitating a financial meltdown, the logical result is rising rates. Thus far, the carry-trade enabled “conundrum” appears to be slowly unwinding. And reality appears to be returning to the fixed income world.

Therefore, if you believe as I do that rates should be higher, the question is not whether rates are going higher. Rather, can rates go up without producing (or at least facilitating) an out-of-control financial meltdown (a/k/a contagion)? In other words, what central banks are trying to do is ease off the liquidity gas pedal without causing the brake to become the accelerator.

Investment Strategy Implications

The technicals strongly suggest that the rate increase is here to stay, the magnitude of which is hard to say. What is not hard to say is the direction, which is up. And the equity valuation impacts are obvious.