How Far Will Treasury Yields Fall?

The yield on 10-year U.S. Treasuries has declined almost 18% year-to-date, is more downside ahead? Not much further is my expectation as technicals combine with sentiment extremes to mark the bond rally’s (ChicagoOptions:^TNX) end.

The month of May was all about bonds as they hogged the media spotlight with the longer maturing bonds recording a 3% gain. But taking a look at the bigger picture, the recent bond rally looks to be counter-trend.

Bond prices have now run into key resistance levels that should end the recent rise in prices and falling yields.

May was good for bonds

Here is the rundown for May:

• iShares Barclays 20+ Year Treasury (NYSEARCA:TLT) +3.0%
• iShares Barclays 7-10 Year Treasury (NYSEARCA:IEF) +1.8%
• SPDR Barclays High Yield Bond (NYSEARCA:JNK) +0.9%
• iShares High Yield Corporate Bond (NYSEARCA:HYG) +1.2%

But it’s not just been May, 2014 has been wonderful to bonds, far outperforming stocks.  For instance the 20+ Year Treasury has rallied over 13% the last five months.  Municipal bonds (NYSEARCA:MUB) haven’t done quite as well, up 6.2% for the year, but they have still outperformed the S&P 500 (NYSEARCA:SPY), up only 4.8% for the year.

Technicals and Sentiment

The technicals, however, suggest the bond rally is near an end.

The chart below was provided along with analysis to our subscribers showing that bonds are running into key technical resistance levels that often mark the end of trends.

First off bonds’ top occurred in July 2012 when the 30 year Treasury yield hit as low as 2.46%.  Since then yields rallied into December 2013, reaching as high as 3.96%.  That trend in falling bond prices is shown on the chart of TLT below.  The green trendline has connected the major tops in bond prices since that 2012 inflection point and is now acting again as resistance.

For three months bond prices have tried to rally over this resistance, and thus far have not been successful.

In addition, Fibonacci retracement levels have already been reached and are typical price levels counter-trend moves react to.  TLT’s $115 price is the final Fibonacci resistance shown in blue and thus far also is rejecting price.

Finally, sentiment extremes often occur along with price extremes.  Recognizing sentiment extremes can be as simple as listening to your popular stock market television show.  Bonds have been a major talking point as the commentary seems to be nonstop concerning the “unstoppable” bond rally.

More so, by analyzing the futures markets we can segregate the smart money investors from the dumb money investors. In a video titled ” Why were bullish when everyone else was bearish,” we used this same approach to score a 66% gain in gold.

Sentiment on the 30-year Treasury bond is now skyhigh, specifically, speculators (who are notoriously wrong at key turning points) are very bullish with large amounts of bullish bond bets, expecting the trend to continue.  However, the typically “smart money”, the hedgers, are the most short they have been since the July 2012 bond top.  The hedgers are historically on the correct side of the market at key turning points.

Combining sentiment extremes, such as those outlined above, with price technicals, which are now butting up against key resistance levels, suggests the bond rally (NYSEARCA:TLT) is about to end.

The ETF Profit Strategy Newsletter utilizes sentiment, technical, and fundamental analysis sprinkled in with some common sense to keep investors on the right side of the market.  The bond market’s 2014 rally is likely running out of steam and should resume the trend of higher yields over the coming months.