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My article, Seeking Beta in the Bond Market: Update December 31, 2010, showed that my Bond Value Ratio (BVR) model indicated the beginning of an up-market for high-beta bond funds on 12/17/10. I present a further indicator here which reinforces this signal.
Figure 1 shows a measure of the steepness of the yield curve. It is a graph of Δi30, which is the 30-year Treasury yield (i30) less the three-month Treasury yield (i0.25), i.e. Δi30 = i30 – i0.25. It is evident that, for the period of this study (1965 to 2011), Δi30 has never exceeded 4.5%.
Figure 1 also shows ΔCPI, the one-year moving average of the annual percentage change of the Consumer Price Index (CPI), plotted together with i0.25. There is a high correlation between ΔCPI and i0.25, indicated by a correlation coefficient r = 0.72. The values of ΔCPI and i0.25 are also not far apart. This means that inflation expectations are mainly reflected in the three-month Treasury yield and not in Δi30.
Investors in 30-year Treasury bonds seem to be content with a maximum yield of i30max = i0.25 + 4.50%.
Figure 2 shows a graph of the BVR with the upper- and lower-switch points, indicating bond market direction. For an explanation of BVR see my article, Seeking Beta in the Bond Market: A Math-driven Investment Strategy for Higher Returns.
The exponential moving average (EMA) of Δi30 with a smoothing factor of 0.40 is plotted together with an upper limit line of 4.40% in figure 2.
A buy signal for a long-bond fund is obtained when the following simultaneously apply:
- 4.40 > EMA Δi30 > 4.35
- EMA Δi30 four days ago - EMA Δi30 now > 0
