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Keep Your Eyes On the Treasury Market

10/17/2012

Whether or not the beginning of a larger reallocation out of Treasuries is unfolding at this point is mere speculation. Candidly, I just do not know yet based on the evidence. However, what I do know is that I am paying close attention to the U.S. Treasury market right now and investors should be also. I am placing U.S. Treasuries on alert for a larger sell-off toward a 2% yield for the 10-year.
 
This week there appears to be significant selling pressure for Treasuries with subsequent capital raised being placed in equities. The S&P 500® Index (SPX) (Figure 1.1) found support last Friday, troughing at 1425.53, just above the all-important 1422.38 support level I identified in my Q4 Playbook. There is no doubt that the subsequent SPX rebound has been correlated with the 10-year Treasury yield appreciating from 1.656% on Friday to 1.80% today. The yield on the 10-year is now perfectly positioned to challenge the closely watched 200-day moving average (Figure 1.2) at 1.8077%
 
On today’s CNBC Halftime program, Goldman Sachs Asset Management Chairman Jim O’Neill joined us for his interpretation of the capital markets and global economy. Much of Jim’s focus was on the recent improvement in U.S. housing data. In addition to Jim’s accurate housing assessment, I would highlight other recent economic strengths that appear to be motivating Treasury investors to pare back holdings.
 
•  Friday, October 12 – University of Michigan Consumer Confidence (Figure 1.3) is reported at 83.1, the highest reading since September 2007.
•  Monday, October 15 – Retail Sales at +1.1% beats the +0.8% estimate and last month’s +0.9%.
•  Tuesday, October 16 – CPI upticks to 2.0% from last month’s 1.9%, a good move away from deflation.
•  Tuesday, October 16 –  Industrial Production climbs 0.4% after last month’s 1.2% decline.
•  Wednesday, October 17 – Housing Starts (Figure 1.4) surge 15% month on month to 872,000 units above last month’s 750,000.
•  Wednesday, October 17 – Building Permits surge 11.6% month on month to 894,000 above last month’s 803,000.
•  Over the past four days, reported earnings for financials heavyweights Citigroup, Goldman Sachs, JP Morgan, and Bank of America have all met or exceeded analyst estimates.
 
Quite candidly I suspect the SPX is very fortunate for the Treasury selling of the past few days. Technology, the 2012 market leader, has struggled this quarter and placed the SPX in a precarious position. The Treasury price action averted an SPX breakdown below 1422.38. 
 
The evidence suggests watching the 10-year Treasury closely. Further appreciation toward 2% should correlate with a new SPX high for 2012, above the current high of 1474.51 established on September 14. Should the 10-year lose its near-term momentum, then the SPX will need to find support elsewhere and will likely remain in a sideways range. Either way, I suspect the direction of the U.S. 10-year is now a leading indicator for overall SPX direction.    
 
Figure 1.1 SPX 500 Index with 1422.38 Support Annotated

Source: Bloomberg
 
Fig 1.2 U.S. 10-Year Treasury Yield, July 1, 2012 to Present

Source: Bloomberg
 
 
Figure 1.3 University of Michigan Consumer Confidence Survey, June 2007 to Present

Source: Bloomberg
 
Figure 1.4 Housing Starts, 2006-2012

Source: Bloomberg

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