For the last three decades, the bond market has been in the midst of a secular bull market: as bond yields have plunged from their highs in the early 1980s to their recent lows, bond prices have correspondingly climbed. Like any market movement, that hasn’t always been a smooth and even pattern, but it has been a consistent and notable trend – and one that nearly every financial advisor and private banker has been warning their clients is now at an end. The yields on 10-year Treasury notes have hovered around 2% since the latest installment of the European sovereign debt crisis, and, as investment managers point out, how much lower can yields on the 10-year Treasury note fall?

The answer to that question is that they may fall by as much as another full percentage point– or at least, that’s what some technical market analysis shows. It’s the scenario discussed in this week’s Idea of the Week, an investment insight based on Thomson Reuters Eikon charts. (For the full explanation of this thesis, watch this video presentation.)

The stage was set last summer, when comments by top European officials that the sovereign debt crisis may not be able to be contained within the periphery of the eurozone, and that it could spread to some “core” nations, ignited a wave of fear and uncertainty in global markets. (There are some signs that those forecasts were prescient: as the European crisis has continued, German exports are slumping; France’s unemployment rate now hovers at around 10% and its bond yields, while low relative to those in Spain, have climbed to about 2.48%.) In the wake of those comments, stock markets in both Europe and the United States plunged 3% to 4% as investors bolted for safer havens. Not surprisingly, one of those safe havens was the Treasury market. Within seven weeks or so of the August comments, the active futures contract on the 10-year Treasury note saw its price soar from 126 to slightly above 132. Meanwhile, in the cash market, yields on the 10-year Treasury plunged from 2.86% in August to 1.8% by late September.

Since then, those prices and yields have remained little changed, trading in a very narrow range and essentially moving nowhere but sideways, stuck in what some refer to as a “congestion zone.”[Grammar Girl says quotes are a fence and keep the stuff inside the fence.] Technical analysts refer to this as a “continuation pattern” since, once the sideways movement ends, typically the markets return to the prior trend and “continue” to follow it. In the case of bond prices and bond yields, those directions are up and down, respectively.

Last summer, the market clearly demonstrated that it is capable of sudden and violent moves in response to some external event. Certainly, there are plenty of storm winds blowing that might prompt a similar reaction. On the economic front in Europe alone, there is the intensifying battle over a possible rejection of austerity by countries such as Greece and France in the wake of recent election results. (There is even the prospect of some eurozone members, such as the Netherlands, abandoning monetary union as a failed experiment.) Geopolitical issues could spook investors – Iran’s nuclear program or any other Mideast crises, for instance. While by some economic measure, the U.S. economy looks relatively healthy, it’s not inconceivable that uncertainty over 2013 tax rates could spark a flight to safe havens, or that a few batches of subpar economic data from the United States, China, or elsewhere could revive investors’ fears.

In an uncertain environment, fear may win the day – and it’s that fear that could drive interest rates on Treasuries to 1% or even lower, as investors scramble to own assets that they believe will retain their value in uncertain times.

Technical analysts examining the charts that portray the 10-year Treasury yield over the last month see clearly that to the extent that if the Treasury bond breaks out of its current range, the probability is that the yield would resume its decline that came to a halt last September, as can be seen by the Eikon chart in Figure 1. The yield’s current floor of 1.8% would become its ceiling, according to the textbook scenario, and the move to the downside would be roughly of the same magnitude as that recorded late last summer – one percentage point. In other words, the 30-year bull market in Treasury bonds may not be over just yet: we may still see yields tumble to 1%, or even as low as 0.8%, a full percentage point below current levels.
 

Figure 1: The US treasury 10-year rate may move down to as much as 0.74. Even if it doesn’t fall this far, such a directional move may spook bond bears into covering their short positions.

You don’t think that’s likely? Well, in each of the last seven weeks, the 10-year Treasury note has seen higher prices and lower yields, with the most recent move coming on the heels of the Greek election results. The most active futures contract on the 10-year Treasury note now changes hands at a price of 133.3, and has been as a high as 133.5, having already broken above its congestion zone level of 132.25.

How low can Treasury note yields go? In the absence of a crystal ball capable of foretelling the future, that’s an unanswerable question. But in the eyes of technical analysts scrutinizing their charts and aware of historical price patterns, it is clear that today’s yields could be cut in half by another sudden fit of market jitters.

 
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