The Bond Chart I’m Watching Right Now

Bonds have begun to come back to life in 2014 as traders began to realize that the Federal Reserve pulling back on its bond buying program is not the end of the world and that sentiment towards bonds is at record lows. I began getting interested in the bond chart back in September when the Barclay’s Aggregate Bond Index ($AGG) was holding support and seeing bullish internals. I’ve also been discussing the range the 10-year Treasury yield has been in with resistance at 3% in my weekly Technical Market Outlook.

Today I want to take a different look at the bond market, specifically the ratio between the long-dated Treasury bond ETF ($TLT) and the shorter-term bond ETF ($IEI). Typically during strong price action in the bond market we see investors move further out on the yield curve as they chase duration – i.e. showing a stronger preference for 20-year Treasury bonds ($TLT) than 3- to 7-year Treasury bonds ($IEI).

For the last half of 2013 we saw the ratio between $TLT and $IEI begin to bottom. While at the same time the Relative Strength Index (RSI) started to put in higher lows as it created a positive divergence. What was also interesting during this period was if we look at On Balance Volume of the ratio (bottom panel of the chart), which shows us if volume has been favoring $TLT or $IEI. As you can see, a strong divergence in this buying pressure (On Balance Volume rising) had been going into longer duration bonds than shorter-term Treasury’s.

When momentum (RSI indicator) and volume (On Balance Volume) begin to act in concert with one another, we often see price begin to play ‘catch up’ as it confirms the internals.

Now we have the ratio between these two bond ETFs testing its 200-day moving average which has acted as decent support over the last two years. If we take a look once again at the Relative Strength Index we can see that the past two divergences (lower highs while price makes higher highs) after becoming ‘overbought’ have led to a trend change that favored $IEI over $TLT.

At the moment we just have the RSI indicator over 70 but no divergence as developed just yet. What I watch for is if the RSI is unable to follow price higher and stays under the 70 level as it diverges. A lower high above 70, while a divergence, still shows buyers pushing momentum overbought, which can be read as bullish. It’s possible we could see a repeat of 2012, where the RSI indicator breaks 70 and then breaks it again as buyers continue to favor the long-duration trade.

Sentiment towards bonds continues to sit at historic lows as it seems traders are refusing to acknowledged the (so far) short-term trend change that’s taken place in the bond market. Going forward I’ll continue to monitor the relationship between long-dated and short-dated duration ETFs and see if the bond market can continue higher or if we begin to see a divergence in momentum as the first clue to a shift back to $IEI from $TLT.
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Disclaimer: Do not construe anything written in this post or this blog in its entirety as a recommendation, research, or an offer to buy or sell any securities. Everything in this post is meant for educational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in the blog. Please see my Disclosure page for full disclaimer. Connect with Andrew on Google+, Twitter, and StockTwits.