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Treasury Diamonds Are Forever

08/13/04 11:10:01 AM
by David Penn

How much longer will long rates trend lower?

Security:   $TNX
Position:   N/A

One month ago I suggested that longer-term interest rates were likely headed lower -- on a short-term basis ("The Ten-year Treasury Yield's Diamond Bottom," Advantage, July 12, 2004) -- but would probably turn higher shortly thereafter. Today, I look at the $TNX -- an index of the 10-year Treasury note yield -- and note that what was at 44.43 (roughly 4.44% yield on the T-note) back in mid-July is now 42.54 (roughly 4.25%), approximately a 19 basis point move to the downside in one month.

There has been relatively little attention paid to declining long rates -- and the accompanying mini-bull/bear market rally in bonds. This is probably because at the same time that long rates were peaking, stock prices had begun to move down in earnest and the economic focus since June has been on the correction in stocks rather than the move up in T-notes.

Figure 1: Peaking in May, 10-year T-note rates tumble toward potential support near 4.1%.
Graphic provided by: Prophet Financial Systems, Inc..
My initial anticipation of the correction in long rates came courtesy of the diamond bottom pattern I described a month ago in the above-mentioned article. Essentially, this correction is serving the purpose of a pullback from $TNX's breakout from this diamond bottom -- a diamond bottom that has its origins in the summer of 2002.

If the analysis of the diamond bottom is accurate, then $TNX should begin to find support at or near these levels. This support could come from the breakout point itself at about 42 (or 4.2%), or perhaps along the downwardly sloping trendline that forms the upper right hand side of the diamond pattern. Even below these levels, a major lower low in the $TNX would not occur until it took out the Q1 2004 low at about 37 (or 3.7%). And until that lower low is taken out, the prognosis for the $TNX remains bullish.

Figure 2: Two years in the making, this diamond bottom in $TNX suggests a powerful surge in long-term interest rates in the months to come.

The upside projection of the diamond bottom, by the way, remains unchanged by recent price action since the breakout. An initial upside of 57 (or 5.7%) is expected once (or "if") the $TNX resumes its uptrend. This upside is derived by adding the size of the diamond (15) to the value at the point at which prices broke out (42).

David Penn

Technical Writer for Technical Analysis of STOCKS & COMMODITIES magazine,, and Advantage.

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