Chart of the Week: 10-Year Treasury Yields and Housing (Requires Free Registration)

This week’s chart of the week is the yield on the 10 year Treasury bond (symbol: $TNX.X).

We last looked at this important index back on January 14, 2013. At that time, not only did I suggest that yields on the 10 year were in a bottoming process, but I also suggested a price target of 2.475%. This week’s strong showing and close over the key resistance zone at 1.869 to 1.897% confirms the original analysis. Yields are headed to 2.475%. Resistance now becomes support.

So how would rising bond yields affect the markets? Over the past 4 years, rising yields/ falling bond prices have been associated with “risk on” environments, but at some point, higher yields will slow the equity rally. Rising yields are a late cycle event, and industrial materials or “rocks over paper” tend to do better in a rising yield environment. Crude oil would be a good example of an asset class that should outperform in a rising interest rate environment. Gold should continue its underperformance.

One sector of the market that might be hit particularly hard by rising interest rates is housing. There is no question that the ultra low interest rates on the 10 year Treasury bond are also reflected in the ultra low mortgage rates. In addition, there is no question that these generationally low mortgage rates have helped stabilize and then support the housing market.

This is a weekly chart of the SPDR S&P Homebuilders ETF (symbol: XHB). Many analysts have stated that the economic recovery will be bolstered by improvement in housing. And yes, the housing sector has been improving since 2009. The XHB or homebuilders ETF has had two measured moves of 100% since the bottom in 2009. Prices went from about 10 to 20 in 2009 and 2010. After going sideways for 18 months, prices doubled again from 15 to 30, which is where we are now. How much more fuel could be left in housings tank?

And now that interest rates and mortgage rates are rising, how much of a leader can housing really be? Lakshman Achutan of the Economic Cycle Research Institute makes the point that home prices are increasing but housing activity or housing starts is about half of what has been seen in prior booms. Technically, the XHB ETF is at resistance levels resulting from the breakdown in prices seen in June, 2007.

In summary, interest rates on the 10 year Treasury bond will rise to 2.475%. In this environment, hard assets should outperform. A prior market leader, housing, will likely underperform.

Lastly, I wonder if there is any significance to the fact that yields have YET to break the low yields seen in December, 2008 at the depth of the financial crisis. This past week they closed just below this level. If yields do go higher, which I believe, should this be taken as a sign that the economy has really turned the corner?