The Economy Pressures Yield

By Jim Farrish | September 03, 2008 | 8:38 AM | 1 Comment

Fear, the economy and financials have pushed the 10 year treasury yield below 3.8%. The importance of this level short term is the July low for yield on the 10 year Treasury Bond. This leads to a twofold question, are yields going to test the March lows of 3.4% and does this signal a test of the July lows for equities? The lower yield has resulted in a rally for bonds. In June the yield peaked at 4.26%. Since that point the continued challenges facing the financial stocks has put pressure on yields as the flight to quality movement returned. The simple question, will the trend continue? A quick look at the daily chart shows a move below support for the yield at 3.8%. A confirmed break would open the door for a test lower on yield. If this occurs I would look for a test of the July lows in equities. Why? A continuation of the fear epidemic to push yields lower. There is plenty on tap to produce that fear so there is the potential yields to break lower and bonds to rally.

 

 

The break below the 3.8% mark does not signal an automatic rally in bonds. There are some outside events at work. The economy is not the least of which to watch near term. There are signs of improvement, but the belief factor is still not enough to reverse the trend. The Fed is still on tap to raise rates to curb inflation. The data is showing a slowing, but the PPI and CPI are still well above the comfort level for the Fed. I would look for the yield to rally back to resistance at the newly formed downtrend line. That would be around the 4% mark. (NYSE: IEF) is the iShare Lehman 7-10 year Treasury. If yields move lower holding the break below support you can play the ETF long. If the yield rallies back towards the trendline you can short the ETF. ProShares UltraShort 7-10 year Treasury (NYSE: PST) is  another way to play the bond short without having to actually short the ETF. This is leveraged so be aware of the increased risk you take and adjust your trade accordingly. The challenge for remains the economy which is putting pressure on yields to move lower in conjunction with equities.