Ick. Technical trading.
Posted on 05/12/2003 8:53:06 AM PDT by AdamSelene235
NEW YORK (CBS.MW) -- Long-term interest rates can't possibly go lower, can they? And if they do, isn't that a good thing?
I figured I had roughly picked the bottom in long-term interest rates when I refinanced my mortgage recently. There is just no way America could get trapped in the same deflationary spiral that has crippled Japan for over a decade.
But then I watched incredulously as the yield on the benchmark ten-year Treasury bond took another dramatic dip last week despite belief in the stock market that the worse was over. The rate fell through one chart point and came dangerously close to another after the Federal Reserve put "D" word -- deflation -- in the minds of bond investors (read more).
That should be bad for the U.S. dollar as foreign investors search for higher returns elsewhere, and it has been. The buck has sprinted to fresh four-year levels versus the euro, and the slide against the yen has brought it to the edge of a technical cliff.
Meanwhile, if long-term rates should continue to fall, it could spark another wave of refinancing and be good for mortgage company stocks, right? Not necessarily.
Shares of government-sponsored Fannie Mae (FNM: news, chart, profile) have been consolidating over the last month, following a sharp rise off their March lows. These "flag" patterns normally suggest the previous move will resume eventually.
The stock does look ready to turn the corner, but to the downside.
One support down, one more to go?
The resolution of the Iraq war gave investors reason to believe the worst was over. They believed the economy was now free to rebound, and stocks long-term rates just had to go up (just ask any mortgage banker) as growth spurred spending and inflation.
But for some reason they didn't. The yield on the benchmark 10-year Treasury bond ($TNX: news, chart, profile) could not sustain any moves above the 4 percent mark despite gains in stocks as economic data continued to be mixed at best. As time passed, every attempt to do so was less and less successful.
Then, amid speculation that the Fed may buy Treasury bonds to inject liquidity into the banking system (read more), the yield took a mid-week dive and closed Friday at a pre-war low of 3.68 percent.
The 10-year yield had seen strong support just below 3.80 percent, as three prior attempts (April 1, May 1 and May 6) to break below it proved unsuccessful. When the yield "gapped" lower on Wednesday -- the high (3.75 percent) was below Tuesday's low (3.799 percent) -- it in turn created a layer of resistance overhead (read more).
Now the yield has dropped dangerously close to the next big chart point -- the 45-year low of around 3.55 percent hit in both October 2002 (3.559 percent) and March 2003 (3.549 percent). The timing just happens to coincide with the lows hit in the major stock market indexes.
A break below that level and who knows? It's no longer inconceivable that deflation fears flatten the yield curve -- the difference between longer and shorter term rates -- enough to bring the 10-year yield down close to the yields on the 5-year Treasury bond (2.64 percent on Friday) and maybe even the 2-year (1.45 percent).
Nancy Kimelman, chief economist at SEI Investments, noted that deflation is a reality in much of Asia, and is close to a reality in Europe.
"In my opinion, due to the globalization of markets and trade, deflation is an imminently exportable commodity, so the risks of deflation hitting North American shores is quite real," Kimelman said.
I may be refinancing again soon. But that's not necessarily a good thing.
Dollar teeters at technical cliff
The dollar's demise against the euro has made headlines. The buck fell in intraday trading on Friday to within 1.1 percent of where trading of the euro initially launched ($1.16675) in January 1999 at the height of euro mania.
But the decline against the yen may get a little more interesting. The strong yen has crippled the Japanese export sector and has been contributing to weakness in the world's second biggest economy by fueling deflation fears.
Last week, the dollar fell enough to threaten to a complete a two-year old "head-and-shoulders" pattern.
The "shoulders" are defined by the April 2001 and October 2002 highs (around 126.80 and 125.75, respectively), and the top of the "head" is marked by the February 2002 high (135.15). A break below the "neckline" -- the line connecting the September 2001 (115.80) and July 2002 lows (115.50) -- completes the classic bearish pattern.
It's no wonder that the drop late last week to the low-116 area prompted comments from Japanese officials for the umpteenth time that the yen was too strong. Japan's central bank did not actually confirm that it intervened to buy dollars/sell yen, but just ask any currency trader what they think.
The buck hit a low of approximately 116.00 last week before closing Friday at just above 117.00.
Falling rates may kick Fannie Mae, again
As interest rates rose off their March lows, Fannie Mae shares shot up to a seven-month high of $74.49 on April 23, a 28 percent rally of its March 11 low of $58.40.
But since April 15, the stock has gone nowhere. The bottom of the range is defined by the intraday lows April 15 ($71.32), May 1 ($71.50) and May 8 ($71.40), while the top is the horizontal line attached to the April 23 high (see java chart).
This type of pattern is known as a "flag." The fact that the stock doesn't pull back while bulls are taking a breather (in effect, working off overbought conditions) typically indicates bulls are still in control, and that the preceding trend will eventually resume.
But the renewed slide in bond yields puts the typical scenario at risk.
In September of last year, the stock tumbled 21 percent during the month as a surge in refinancing due to falling long-term rates prompted worries about the agency's "duration gap" (read more).
In addition, the stock's "momentum" indicator -- which depicts a move's power by measuring the rate of change over a specified time period -- has been declining since mid-March despite gains in the stock and fell below zero at the end of last week.
This suggests that bulls are out of breath, and have become susceptible to a downside strike by the bears (see previous column regarding "negative divergence").
Of course, this is no guarantee that the bottom of the "flag" pattern will give way, but it may be enough to prompt those with profits from lower levels to cash in.
If the stock happens to close below $71.40, support should become apparent around the $69.50 level, where it broke out of a minor "flag" pattern in early April. Below that, the $67 level -- the stock topped out there a number of times in late March -- will likely attract buyers.
On the upside, it's unlikely the stock can sustain a fight through the $74.50 level without help from the "momentum" indicator.
Ick. Technical trading.
Richard W.
A flat yield curve is significant for Fannie's business and her counterparties.
Perhaps you missed this bit:
It's no longer inconceivable that deflation fears flatten the yield curve -- the difference between longer and shorter term rates -- enough to bring the 10-year yield down close to the yields on the 5-year Treasury bond (2.64 percent on Friday) and maybe even the 2-year (1.45 percent).
Then how will Fannie pay its bond holders? How will it manage its 60 to 1 debt to equity ratios? They have more debt than the publicly held Treasury debt and a trillion + in illiquid derivatives.
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