Interest rates are staging a massive breakout…
We can thank the Federal Reserve for that. It chose to hike rates once again in July to as high as 5.5%. That’s a level not many folks would have thought possible just a few years ago.
Other interest rates are soaring as well. The 10-year U.S. Treasury yield is up around half a percent since July. And it recently hit its highest level since 2007.
But according to one measure, sentiment toward 10-year bonds is far too negative. That means the uptrend in yields could soon reverse… And when it does, the decline could be a big one.
Let me explain…
For most of the 2010s, investors were smart to ignore interest-rate markets. Fed policy kept interest rates near zero for most of that time… So there just wasn’t much to think about.
That isn’t the case today, though. Interest rates are up in a big way. You can now earn a solid yield on your cash. And suddenly, it’s crucial for investors to pay attention.
You see, these markets operate just like stocks when sentiment gets out of whack. When everyone expects one outcome, the opposite scenario usually plays out.
The 10-year Treasury yield recently broke out to 4.3%… taking yields to a 15-year high. And, not surprisingly, futures traders expect rates to soar even more.
That means traders are incredibly bearish on government bond prices right now. (Remember: bond prices and yields move in opposite directions.) We can see this sentiment through the Commitment of Traders (“COT”) report…
The COT is a weekly report that shows what futures traders are doing with their money in real time. Like most sentiment indicators, it tells us when a market is in an extreme state and primed for a reversal.
Today, futures traders are betting on higher 10-year yields – and lower bond prices – in droves. The chart below shows 10-year Treasury yields versus the COT for those bonds. Take a look…
You can see that the recent low is by far the most bearish these folks have been in the past decade.
That sentiment low happened in May. But the COT has already gotten darn close to that level once again, now that 10-year yields have surged to a 15-year high.
The chart also shows that similar setups led to huge declines in 10-year yields in the past…
The first instance was in 2017. Futures traders were they most bearish on bond prices they’d been in years. Then, 10-year yields fell from roughly 2.5% to about 2% in less than a year.
The same thing happened in 2018. The COT hit a rare sentiment low. Rates peaked about a month later… And then a massive downtrend began. Overall, 10-year yields fell from nearly 3.25% to below 1% in less than two years.
This year, we’re in a similar situation. Speculators are betting that rates will keep surging. That’s not surprising, given the massive move higher we’ve already seen… But these traders won’t be right for long. History shows a reversal is likely from here.
Now, interest rates are still in an uptrend today. So it wouldn’t be smart to bet on a reversal right away. We have to wait until rates begin to fall.
Once they do, though, the decline could be huge. Make sure you watch 10-year Treasury yields closely in the coming weeks.
This article was originally published on this site