So, the Federal Reserve Open Market Committee lowered the target Federal Funds interest rate by half a point, to 3 percent. In response, the Dow Industrials promptly rocketed up 200 points and then just as quickly headed south, ending 37 points down on the day. It seems that a half point drop was still not enough to satisfy the players. It was not enough candy, because even at 3%, the Federal Funds rate is still about three-quarters of a point higher than the 3-month Treasury Bill rate. The Fed lags the Treasury Bill market, which is par for the course. The Fed has been behind the declining T-Bill curve for the past year.

Something has to give, because this disequilibrium is unsustainable indefinitely. (Recall that Treasury Bond [and Treasury Bills] interest rates [i.e., “yield”] move inversely as to the price). Either the Fed Funds rate will be driven down further, or the T-Bill market interest rate will be driven up (and therefore prices will decline), or both.

The following chart shows that prices have, in fact, begun to decline.

Note that the price bar of January 22 was a “High-Wave Spinning Top” in Japanese Candlestick terms, and that (as of that day) it was also an Island Top, both of which patterns are warnings of a possible reversal to the downside. Even more importantly, the price bar of January 23 was a “Last Bullish Engulfing” Candlestick pattern, which is a strong downward reversal warning pattern. It was confirmed the next day by a lower close, and prices (and therefore the interest rate) have continued sideways to slightly lower, so far.

The Last Bullish Engulfing pattern is further confirmed by the High-Wave Spinning Top in the Weekly chart:

It is to be noted, also, that the 10-day Daily Sentiment Index in 10-year Treasury Notes is at an extreme 92.6 and that the Relative Strength Index has diverged from price action since early in December (not shown).

The bottom line is that, regardless of possible future additional reduction of the Federal Funds rate by the Federal Reserve Open Market Committee, prices of T-Bonds and of T-Bills will likely continue to decline (and that interest rate yield will therefore continue to increase) over the near term, which will tend to drive the Federal Funds rate and the market interest rate toward convergence.

William G. Kurtz Jr.
http://www.candlewave.com/candlewave.htm