Are Interest Rates Set to Rise?

Interest rates play an integral role in the functioning of economies and markets.

From a Keynesian monetary school of thought, the increase or decrease in rates will either slow or drive economic activity, respectively.

For example, when interest rates are low it is easier to fund projects and expansionary plans with cheap credit. Conversely, as interest rates rise it will become less attractive to issue new debt at a higher rate to take on the same type of projects.

Accordingly, assessing the current state of the interest rate market by looking at the US 10 Year Treasury Bond Yield Index (TNX) we can begin to see if changes in Fed policy from a dovish to hawkish stance are being reflected in the marketplace.

Long-Term Perspective

Looking at the monthly chart of TNX there are a few bullish developments.

First, while TNX formed a lower low in 2016 after the its previous low in 2012 its Moving Average Convergence Divergence (MACD) formed a higher low at the same point in time. When this it occurs it is called positive divergence and usually precedes an increase in the value of price of a security or an interest rate.

Divergences on monthly charts typically take time to unfold as they represent slow-moving, systemic shifts in asset allocations. However, divergence on the long-term charts is quite reliable in foretelling a powerful, lasting trend is beginning.

Second, TNX is breaking out this month above previous resistance from the beginning of 2017 as well as support at this level back in 2010.

Given the positive divergence underlying this reactionary uptrend, relative to the long-term downtrend in interest rates, there could be more upside in the months to come in TNX.

However, despite these two positive developments in reversal of the multi-decade downtrend in rates, the Average Directional Movement (ADX) indicator has yet to signal an uptrend is underway. Instead, the decline in ADX to 14.78 represents a consolidating market. However, with positive directional movement (+DI) over negative directional movement (-DI) traders should watch for ADX to pick up from its current levels and turn up toward 20 or more as this would confirm an uptrend is underway from a probabilistic point of view. 

Tactical View

On the daily chart we can see several positive developments as well.

From a tactical asset allocator’s perspective it is bullish to see the 50-day Simple Moving Average (50SMA) cross above the 200-day Simple Moving Average (200SMA). Moving average calculations were first used by rocket scientists to track the trajectory of an object in orbit. Similarly, traders use moving averages of different time frames to assess the trajectory of price.

In other words, with the 50SMA over the 200SMA and trending upwards the intermediate term trend can be considered up and traders should be looking for opportunities to buy strength off of pullbacks or get long on breakouts.

Presently, TNX is breaking out to a new high. Over the past week price has formed a textbook, orderly bull flag and we are seeing a continuation of the move today. Additionally, the daily Relative Strength Index (RSI) for TNX is now above 70 on this breakout.

RSI is an oscillating indicator that represents overbought and oversold conditions at 70 or greater and 30 or lower, respectively. In order for the intermediate-term uptrend to be sustained, TNX will need to continue to register readings over 70 on its RSI. Otherwise, negative divergence will develop which can precede an impending change in trend.

For now, the short-term uptrend remains in place as ADX is trending up with a value of 19.95 and +DI well above -DI. When daily ADX reaches a value of 20 or greater after being below 20 it often leads to a strong trend in the coming days to weeks. 

Key Takeaways

Bullish developments in the US interest rate market certainly cannot go overlooked as changes in rates will ultimately impact all sectors of the economy.

While the US Federal Reserve continues its long-term plans to incrementally raise interest rates at this point in the economic cycle, the market will price in its long-term expectations as well.

Accordingly, traders and investors should monitor the trend in interest rates for any developments that may contradict the hawkish tone by the Fed and emerging uptrend in TNX.

As always, please feel free to contact me with any questions or comments. Thanks for reading!

John