The good news is that TNX tagged our next upside target this morning — the neckline of a fairly large IH&S Pattern that we first detailed back on Jan 9 [see: China – It’s Not Me, It’s You.]  The bad news is that this isn’t shaping up as a clean reversal.To see why, we must examine DXY — which also isn’t shaping up as a clean reversal.  Recall that DXY tagged our downside target range last Thursday [see: US Dollar – Capitulation.]  It was a precise tag of our range (88.438 versus 88.423-88.682) but it stopped just short of an important channel bottom.

Likewise, TNX has resistance just overhead that could come into play in (a) an overshoot, (b) a reversal and later thrust higher, or (c) never.  Fortunately, the upside potential from here is relatively limited, enabling traders to get out ahead of it.  Ignoring cries of “the sky is falling” might prove to be the tougher challenge.

continued for members…

The weekly chart shows the on again, off again relationship between interest rates and the DXY.  Often they move in tandem, which is what you’d expect – higher rates would attract more capital to dollar denominated instruments.  But sometimes, as in the last six weeks, they move opposite one another.If we look at 10-yr note futures, it’s a little easier to see what’s going on. In Aug 2013, ZN started to break down below the yellow channel midline.  This positively correlated with DXY (thin purple line), which threatened to break down below the lows established since Feb 2013.I suspect this made the Fed and Treasury a little nervous — not to mention the note buyers themselves.  As a general rule, when you lend someone over $20 trillion you’d like to think they’ll pay you back.

There’s a red trend line connecting all those bottoms between Aug 2013 and Jan 2016.  Simply put, this means prices were being propped up.

Note, per the TNX chart above, that this was a period of sharp interest rate drops: from 3% to 1.65%, a bump up to 2.5%, then another plunge to 1.33%.  The first drop was in keeping with the rising red channel – not such a big deal.  But, the second saw that red channel break down amidst new lows.

This led ZN to rally even more sharply, breaking out of a steeply dropping channel and rise up to a .886 Fib retrace of its drop from 135 in 2012 to 122 in 2013.   When ZN reached 133 (the .886) TNX bottomed out at 1.33%.

And, this is where things got interesting. After TNX finally bottomed out, it bounced up to backtest the broken red channel at about 1.85.  But, instead of reversing at the channel bottom, it shot through it like a rocket.  Why?  Remember the election, and the incredible spike in USDJPY in order to keep stocks from melting down?  USDJPY’s surge through the yellow channel midline occurred at exactly the same time as TNX’s move back through the channel bottom.  It was intended as a sign that everything was okay.

It was incredibly important from the dollar’s standpoint, too.  DXY was initially smacked down pretty hard once the results of the election became obvious.  But, like equity futures, it magically recovered by the time stocks opened up the next morning.The recovery allowed DXY to backtest rather than re-enter the falling channel from which it had broken out. More importantly, it allowed DXY to maintain the trend line which had been in place since May 2014.Back to TNX…  After popping back into the rising red channel, TNX also managed to pop up through the dashed red trend line from 2007.  This got a lot of attention from technical analysts.

Reversals off this same TL between 2007 and 2011 resulted in large equity selloffs: -52%, -15% and -20%.  The 15% gain in 2014, courtesy of USDJPY’s 25% spike, was an exception.  What would happen if TNX rose back above the same trend line?For those who don’t recall, this breakout in TNX……helped enable SPX to “fix” its election night breakdown and recover back above the IH&S neckline it had already backtested and below which it was sinking fast.

With the history lesson behind us, what do these charts tell us about the future?

As you all know, I believe Fed members lose the most sleep over both higher interest rates and a falling US dollar (which leads to higher rates due to its inflationary effect.)  So, the dollar’s recent slump and rising rates make the road ahead tricky.

TNX’s near doubling from 1.33% to 2.62% between Jul and Dec 2016 resulted in a relatively minor 8.9% rise in DXY.  Not much bang for the buck.

By contrast, DXY plunged 14.8% in the 13 months since then, even though TNX fully recovered (and, more) from its 2017 slump.  Could it be that investors/traders see a rise over 3% as a risk not worth taking?  Bond prices have seemingly broken down with rates’ breakout.  Again, this kind of thing feeds on itself, and could easily spiral out of control — which makes me think about lines in sand.  The closest would correspond with the bottom of the shallow falling white channel – currently around 121’015 on ZN.  In a perfect world, this would correspond with the rising red channel midline for TNX — about where the .382 Fib is at 28.56.

If ZN’s white channel should break down, then support is way down at the rising yellow channel bottom.  If it waits until October, it would intersect with the .500 Fib at 119’180.  If it happens sooner, ideally late April, it would drop through the .500 Fib and intersect with a falling wedge at around 118’300 – probably enabling TNX to reach 30.

The completion, today, of TNX’s IH&S is a bullish development for rates.  But, the same thing happened back in March 2010 — a break above a neckline which turned out to be a head fake.  TNX fell from 40.13 to 23.34 over the next five months.  DXY popped about 10%.

If you’re like me, you might be wondering “what was the point?”  As it happens, SPX had reached and slightly topped its .500 Fib retracement of its drop from 1576 in Oct 2007 to 666 in Mar 2009.  It was falling back below the .500 and rolling over toward its SMA100 and SMA200 (Point 1, below.)

On Feb 4, SPX plunged 3.1% (in one day, really! It used to do that…look it up!) on its way to the SMA200.  Had it reached the SMA200, it would have constituted an 11.5% correction from its January highs.

As “luck” would have it, TNX bottomed out the very next day and started inching higher. This prompted SPX to reverse before reaching the SMA200.

When TNX pushed above the neckline — sending a signal that rates were going much higher — SPX responded by making new highs.  It was only after the breakout broke down that SPX followed suit, falling back below the .500 and tagging the SMA200 anyway.

Of course, it wasn’t higher rates themselves that prompted SPX to move higher.  It was the rise in USDJPY which reflected the increase in rates.  Yep, the yen carry trade was well on its way to superstardom — even before Fukushima.

I know it seems a bit convoluted — the idea that interest rate swings, bond prices, currency pairs and equity prices can be so interdependent.  With index funds and all the passive and semi-passive pools of money tied to them, the algorithms which drive these moves have attained unbelievable influence over equities.  And, the folks pulling the levers on the algo drivers have achieved unbelievable control.

Stay tuned.