A Major Sell Signal for Bonds

06/18/2007 12:00 am EST

Focus: MARKETS

Mary Anne & Pamela Aden

Co-Editors, The Aden Forecast

Pamela and Mary Anne Aden, editors of the Aden Forecast, say bond yields may have broken a decades-long down trend, and their big move up may signal the end of an era of declining rates.

Short-term interest rates and long-term interest rates usually move together, but the Fed does not control long-term rates and this month something strange happened. The major trend for long-term interest rates dramatically turned up. Both the 10- and 30-year [Treasury] yields rose clearly above their 65-week moving averages.

Plus, the leading indicator is rising and it has room to move higher before it's overbought. This means the yield curve is no longer inverted, which is good for the economy, but it also tells us that long-term interest rates are headed higher and bond prices are going lower.

As you know, bonds are very sensitive to inflation, and this reversal is beginning to reinforce that more inflation is coming. That in turn would be good for gold, but it would be bad for bonds. Since bond investors are generally sophisticated and the market tends to look ahead, this reversal is not good news for the Fed.

If inflation does pick up as the market suggests, it'll put the Fed into a real tight spot at the same time that its hands are essentially tied. We'll see what happens but we're currently at a very fascinating crossroads and the way things evolve from here is going to tell us a lot about what we can expect in the period ahead.

The yield [on the 30-year bond] has been declining since 1981 and in recent years it's been building a base above a mega-support level. The long-term moving average identifies the megatrend and it doesn't change direction often. In fact, it's only changed three times in 77 years, but when it did it then set in motion a new era and megatrend that lasted for decades.

The last time this happened was 22 years ago, after long-term interest rates peaked near 15% at the end of the inflationary 1970s and gold had soared to $850. The megatrend has been down since then.

Currently, however, this mega-moving average is at 5.03%, and the 30-year yield has soared above it. It's now at 5.25%. If the yield stays above 5.03%, the megatrend is up, which is a huge new development. It means long-term interest rates are going much higher, that short-term interest rates will eventually follow and that big inflation is coming, similar to what happened in the 1970s.

Leading up to 1981, for example, bond prices plunged 60% in the 1970s, and if a mega- trend change is coming, the next decade could be similar.  That in turn is extremely bearish for bonds, indicating they're poised for a mega-decline in the years to come, and you'd obviously want to be out of bonds completely.

In the meantime, stay on the sidelines. If you're an investor who depends on bonds for income, you'll want to seriously reevaluate your situation and sell all of your bonds if the 30-year yield now stays above 5.03%.

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