Rising Treasury yields are now old news, but how much further
they will rise is cause for great debate.
On one hand, history suggests the yield on the 10 year should be
As S&P Capital IQ explains using the consumer price index (
) as a guide:
"The historical relationship between CPI and the yield on the
10-year note tells a more ominous story. Since 1947 CPI
recorded an average year over year increase of 4.39% while the 10
year averaged 6.16%, implying the yield on the 10-year traded at an
average premium of 1.77% over CPI."
With a current CPI reading of 2.0%, history implies the 10 year
should be trading closer to 3.77%. It currently resides at
But as the popular saying goes, "we can find a statistic for
anything" as the analysis below shows.
Using the VIX to Spot Key Turning Points in the
Again from Capital IQ, this time using gross domestic product (
) to analyze interest rates:
"History offers no solution to the interest rate debate, as it
supports both rising and falling yields. The U.S. economy
grew by 6.39% annually since 1947. During that same period,
the yield on the 10-year note averaged 6.16%." With the most
current year's GDP of 2.93%, this suggests the 10 year should be
closer to 2.7%, slightly lower than the 2.9% today."
And let's not forget about a third wrinkle in the yield
uncertainty, the upcoming budget and deficit debates that are sure
to have U.S. Treasuries (NYSEARCA:SHY) front and center on the
world stage. Some estimates suggest the U.S. will run out of
money by October 1 if a new budget and debt limit is not in
place. Two weeks later, defaults could follow.
How to Hedge Budget Debates and Rising Yields
In July, I wrote about the rising yield curve and implications
of a steepening curve. Contrary to popular believe, a rising
curve is not a bullish event, quite the opposite.
In that article I suggested hedging a rising yield curve by
purchasing the iPath Treasury Steepener ETN
(NYSEARCA:STPP). So far so good, as STPP has risen
from around $39 to over $41 since then.
If Treasury yields continue higher, STPP will continue to
More aggressive traders might want to look into the iPath 10
Year Bear ETN (NYSEARCA:DTYS) which moves inversely to the 10 year
bond price. If yields rise, then the 10 year price will fall
and DTYS will appreciate. Another bearish bond exchange
traded product is the ProShares UltraShort 20+ Year Treasury
Have Muni Bonds Topped?
Muni bonds are wrongly getting lost in the debt debate shuffle
as Treasuries (NYSEARCA:TLT) remain the major focus.
But municipal debt too should be front and center,
especially with Detroit's recent fiasco and Puerto Rico's general
obligation bond yields recently topping 10%.
Risk in municipal debt it seems has never been higher. Yet, the
market has been pricing in ever rosier outlooks. That tide is
finally starting to turn as municipalities feel the pressure of
We have been expecting a top in muni bond prices since
March and I think that this is likely just the beginning.
As outlined in March of this year when I suggested the
trend in muni bonds was over
, municipal bond prices have since fallen over 10% with room
for more downside.
A Way to Hedge Muni Risk
The chart below is one recently provided subscribers along with
commentary surrounding a few trade setups that suggest there indeed
may be plenty more pain for Municipal Bonds.
The top portion of the chart shows that since 2010 munis, as
measured by the iShares National Municipal Bond Fund
(NYSEARCA:MUB), have been underperforming Treasuries. This
chart helps identify strength versus weakness and suggests a
resumption of the weakness in Muni bonds when compared to
Treasuries. Based on the chart, Muni bonds should now start
to really underperform Treasuries.
Is the Worst Really Over for Gold and Silver?
The bottom portion of the chart (in green) also shows that
recently Municipal bonds broke down from their four year long
uptrend in place since 2009. That breakdown is a bearish sign
that the Muni uptrend is likely over with a near term target of
$97, and longer term target much lower.
Couple that long term trend breakdown with the top portion of
the chart that shows Munis are ready to resume their relative
weakness to Treasuries and therein lies a high probability trade
setup shorting Munis and longing Treasuries.
There's another key element to big problems ahead for municipal
When it comes to the debt ceiling and fiscal deficit debates,
the federal government has a printing press behind it.
However, municipalities (as recently seen with the State of
Illinois, Puerto Rico, numerous California cities, and Detroit)
only have population growth and taxes to back their
obligations. This is a primary reason why yields on
Treasuries are always lower (and thus safer) than Munis.
This also means that yields on munis can go significantly higher
than their Treasury counterparts (Puerto Rico at 10% and Detroit
defaulting are great examples).
A continued rise in yields (NYSEARCA:HYD) would send MUB down
significantly more than Treasury Bond ETFs such as TLT or the
iShares Barclays 7-10 Year (NYSEARCA:IEF) and thus would make the
short MUB, long Treasuries pairs trade profitable. Another
way to protect from rising yields is purchasing the iPath Treasury
Steepener ETN (NYSEARCA:STPP).
ETFguide uses fundamental, technical, and sentiment analysis to
stay ahead of the market's trends through our popular
Profit Strategy Newsletter
, Weekly Picks, and Technical Forecast. The Muni bond market
may just be getting started in its decline, and if Treasury yields
continue to rise, it will only pressure municipalities
who already have too much debt.
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