Frothy Yields Introduce Interesting Scenario for US30
Source: www.tradingview.com
The 10-yr real rate (top) has charted a higher trough followed by a higher peak. This price action is a defined uptrend, with the green trendline measuring its momentum. The US30 (middle) has charted a series of lower peaks followed by lower troughs. I.e., the index is in a downtrend, with its momentum measured by the red trendline.
Unsurprisingly, the correlation coefficient (bottom) between the two is at -78%. One of the reasons for the negative relationship is the time value of money. As the real risk-free yield increased, investors' required rate of return has followed suit. This mechanism has weighed heavily on the US30 as its present value adjusted downwards in response.
Source: www.tradingview.com
However, as mentioned in a previous article, the real yield's weekly RSI is overbought (blue rectangle). The longer time frame makes it difficult to assess timing implications, as the overbought condition may resolve over weeks. However, the indicator should normalise this froth at some stage. Therefore, given the TVM and inverse relationship, the US30 may have a floor beneath it.
While the interest rate fundamentals have not changed, bond market activity may catalyse yield normalisation in the shorter-term. If so, we would view this as a correction instead of a trend-change until proven otherwise.
A shorter time frame will be insightful here and help with the potential timing aspect if this scenario unfolds.
Russell Shor
Senior Market Specialist
Russell Shor joined FXCM in October 2017 as a Senior Market Specialist. He is a certified FMVA® and has an Honours Degree in Economics from the University of South Africa. Russell is a full member of the Society of Technical Analysts in the United Kingdom. With over 20 years of financial markets experience, his analysis is of a high standard and quality.
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