Treasury Traders Watching Key Levels

05/19/2011 5:00 am EST

Focus: COMMODITIES

The charts for US Treasuries and the dollar tell a story of an impending crossroads, and with QE2 ending, this relationship is one that traders should keep a careful eye on.

Can you remember the last time that someone was preparing to short Treasuries? It couldn’t be that long ago.

Oh, yeah, I remember, it was when they bounced off of the eight-year rising trend line in the beginning of February. It seemed so simple then.

There were two catalysts: The government was going to continue to spend more than it took in, and therefore, needed to continue to issue more debt. And with the deflating of the dollar through endless rounds of quantitative easing (QE), the resulting inflation would also hurt Treasuries.

Did all that change in the matter of three-and-a-half months? Are we closer to balancing the budget? Has the dollar bottomed?

Many would answer these questions in the affirmative or at least say that we are moving in the right direction. Others would say that nothing has changed. But what do the charts say?

Using the iShares Barclay’s 20+ Year Treasury Bond Fund (TLT) and PowerShares DB US Dollar Index Bullish Fund (UUP) as proxies, they tell a story of an impending crossroads.

TLT vs. UUP – Daily Charts

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The ratio chart above shows the trend higher from the triple bottom from December to February. It rejected at the high at 4.53 previously reached in November earlier this month, but it is now re-approaching it from a higher low.

The relative strength index (RSI) is pointing higher, supporting at least a retest, and the moving average convergence divergence (MACD) is improving. Even the volume is increasing. If it can get through the resistance then, it has its last resistance at 4.60 before it sees clean air and a target of 4.73 on a measured move (MM) higher.

The weekly chart below is even more interesting. It shows that a rise to 4.60 would complete a ‘W’ - ‘V’ pattern. Also note that the over the last four years, the trend for the ratio has been higher. The RSI is trending higher, but the MACD is leveling in positive territory.

TLT vs. UUP – Weekly Charts

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Click to Enlarge

Both time frames suggest that the path for the ratio is higher. That fits with the view that QE2 will end without a QE3. And that as the Federal Reserve keeps saying, any bump in inflation will be transitory. And that the budget negotiations driven by the need to compromise on the debt ceiling will result in reducing Treasury issuance.

Seems like a tall order for just one of these to come true, but hey, this is what the charts say. Or is it? The charts do not guarantee that this will happen. Wait for the break of resistance before you put your money on it. A rejection at 4.53 again and all bets are off.

By Greg Harmon of DragonflyCap.com

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