Market musings - Interest rates

US 10 year treasury yield closed at 1.9434 and is almost on the verge of a break out. Readers may remember that I wrote a post on 19^th December 2012 indicating that yield had broken out.  Yield will face minor resistance at 2.00% and then it should move higher towards 2.5%, 3.0% and eventually towards 4.0%

The second chart is yield chart of Italy. As we can see that Yield has almost moved towards the lower end of the pattern and should take support at 4.0% levels and may bounce back from there.

 

Similarly when we see Spanish 10 year yield chart we can see that yield is trading in an expanding triangle formation and it will find support at around 4.50% and may not move down from here but may reverse. 

Now if I connect all three dots I come to the following conclusion.

1.       If US 10 year yield is going to move up sharply then there is no reason why Spanish or Italian treasury yield won’t go up.

2.       Rise in yield may be the result of three factors, inflation expectations are going to move up, credit risk is going to increase or Yield currently are at abnormally low levels and they will swing upward to adjust for that. (Just like Yen)

3.       If yield goes up it will be counterproductive for equity markets. 

At this moment we may feel that yield will not move up due to QE done by ECB, but charts suggest otherwise and I have always been surprised how well technical analysis works. When yield were trading at 7.0% at the upper end of the formation I felt that it would be next to impossible for yield to move toward lower end of the formation but that happened. Therefore it will be appropriate for readers to be prepared if this scenario fructifies before the end of this year. 

Secondly if we see forecast for Equity market almost everyone is very bullish on markets, Markets have already completed 4 years of bull run and most of the major indices are trading near their all time highs which is a major resistance area (This is not to say that they will not go higher as currently there are no bearish patterns on charts).  

If we look from the perspective of behavioral finance, I feel that everyone now believe that there is only one way for the markets and it will go up.  Therefore lot of dumb money is already flowing into the markets. 

If we couple these observation with probability of central banks globally reducing the quantum of QE due to improved prospects of economy and reduced earning power of stocks due to shrinking operating margins,  it is entire possible that a big correction in equity markets is round the corner. 

My own gut feeling is that we may see some kind of intermediate top in global markets in next 3 -4 months and from there we may see a 25% correction. But before that the last leg of the bull market has to happen which is usually characterize by runaway rallies and culminates into a buying climax. 

All in all, Keep a sharp eye on yields.