Treasury Yields Are Rising; The Fed Will Hike 'When Doves Cry'

NEW YORK (TheStreet) -- The voting spots on the Federal Reserve's Federal Open Market Committee have been dominated by doves for too many years. Today, however, the FOMC appears to have a commitment to end quantitative easing following its Oct. 28-29 FOMC meeting.

The message from Main Street to the FOMC comes from the No. 1 smash hit When Doves Cry by Prince. Homeowners and consumers are singing the refrain, "How can u just leave me standing?" "Alone in a word that's so cold?" "Why do we scream at each other?" "This is what it sounds like, when doves cry"

Main Street will be much better off when it hears the doves of the FOMC cry out that first rate hike and banks begin to pay savers higher rates on CDs and money market funds.

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My bet is that the Federal Reserve will begin hiking rates around the middle of 2015.

The signals that led to a rise (or decline) in yields during my career as a bond trader and then as a market strategist came from my charts and graphs. The benchmarks I track are the yields on the two-year, three-year, five-year, seven-year and 10-year notes and the yield on the 30-year bond.

The relationship between any two maturities is known as a spread. A two-issue spread is calculated by simply subtracting the yield on the shorter maturity from the yield of the longer maturity.

For example, June's closing yield for the 10-Year note was 2.521% with the yield for the two-year note at 0.461%. The two-year/10-year spread ended June at 2.059 percentage points, or 205.9 basis points. At the end of 2013 this spread was 264.3 basis points, so this portion of the U.S. Treasury yield curve had flattened by 58.4 basis points.

This dynamic occurred with the yield on the two-year rising by 0.078% and the yield on the 10-Year declining 0.506%. This is a sign that professional U.S. Treasury traders are betting that the Federal Reserve will raise rates, most likely about six months after quantitative easing ends.

One reason the 10-year yield is lower is the process called curve flattening. This is a reversal of the longer-term trade, which was the bet that the yield curve would continue to steepen as the Fed prolonged QE.

Once quantitative easing ends the biggest buyer of longer-term U.S. Treasuries and mortgage-backed securities, the Open Market Trading Desk of the Federal Reserve Bank of New York, will no longer be purchasing these securities.

On June 18, the Federal open Market Committee (FOMC) instructed the trading desk to reduce the pace of MBS purchases to $15 billion per month and U.S. Treasuries purchases to $20 billion per month. Once this is done, longer-term yields will likely be higher than they are today.

Courtesy of MetaStock Xenith

The weekly chart for the yield on the 10-year note (2.521%) is showing divergences to look for when predicting that the decline in the yield is over and that the trend toward rising yields has begun.

The 12x3x3 weekly slow stochastic reading ended June at 41.32 after touching the 20.00 reading at the end of May. The green line is the 200-week simple moving average, at 2.390%, which has prevented lower yields since the end of October.

The 10-year yield needs to sustain a trend above its five-week modified moving average at 2.572% to solidify the trend toward higher yields that began nearly two years ago.

Looking back to 2007, the yield on the 10-year note was as high as 5.333% in mid-June, a full six months before the Great Recession began. The cycle low for the 10-year yield was 1.381% set on July 25, 2012. That was quite a bond market rally.

Back in mid-June 2007, the iShares 20+ Year Treasury Bond ETF (TLT) ($113.24) traded as low as $82.20. The high in July 2012 was $132.21 for a gain of about 60%. Over the same time frame the SPDR S&P 500 ETF (SPY) ($195.82) traded as low as $149.55 in mid-June 2007 and the high in July 2012 was $139.07 for a loss of 7%.

Since July 2012 the S&P SPDR is up about 40% with the iShares bond ETF down about 14%.

At the time of publication the author held no positions in any of the stocks mentioned.

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This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff

Richard Suttmeier is the chief market strategist at ValuEngine.com. He has been a professional in the U.S. Capital Markets since 1972, transferring his engineering skills to the trading and investment world.

Suttmeier has an engineering degree from Georgia Tech and a Master of Science degree from Brooklyn Poly. He began his career in the financial services industry in 1972 trading U.S. Treasury securities in the primary dealer community. He became the first long bond trader for Bache in 1978, and formed the Government Bond Department at LF Rothschild in 1981, helping establish that firm as a primary dealer in 1986. This experience gives him the insights to be an expert on monetary policy, which he features in his newsletters, and market commentary.

Suttmeier's industry licenses include, Series 7 and Registered Principal (Series 24). He has been the Chief Market Strategist for ValuEngine.com since 2008 and often appears on financial TV.

Click here for details on Suttmeier's "Buy and Trade" investment strategy.

Richard Suttmeier can be reached at RSuttmeier@Gmail.com

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