US ECONOMIC OUTLOOK & COMMENTARY January 16, 2017

Paul Curtis Curtis914@cs.com

www.linkedin.com/in/paulcurtis4

US Yields – Bull Market Turning Point? Technical Developments Spell Potential Trouble for 30+ Year Bull Market in Bonds

US Economic Outlook / Commentary By: Paul Curtis on January 16, 2017

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Could the 30+ Year US Treasury Bull Market be Coming to an End?

1 Yr 2 Yr 3 Yr 5 Yr 7 Yr 10 Yr 20 Yr 30 Yr

1/13/16 0.60 0.91 1.15 1.51 1.85 2.08 2.47 2.85

7/13/16 0.51 0.68 0.80 1.07 1.32 1.48 1.77 2.18

1/13/17 0.82 1.21 1.48 1.90 2.20 2.40 2.71 2.99

0.600.91

1.151.51

1.852.08

2.472.85

0.51 0.68 0.801.07

1.32 1.481.77

2.18

0.821.21

1.481.90

2.202.40

2.712.99

US TREASURY YIELD CURVE

Executive Summary:

Back in the late 1980s, a bull market in US Treasury prices began taking the10-yr UST yield down to an all-time low of 1.33% by July 2016. At some point, this

trend will end and we will then enter into a sustained period of upwardly rising rates. Precisely determining just when this happens is a tricky business especially

when we are discussing a reversal in a trend that has been in place for over 30+ years.

Over the years, my approach in determining the short and long term direction of interest rates has focused on a combination of fundamental and technical

analysis. Ideally, when I can conclude that both are delivering the same message, the direction becomes relatively clear. However, when technical price action

begins to diverge from the fundamentals, as they are now, the long and short term outlook becomes much less clear. Adding to the uncertainty, is the potential

impact of President Trump’s pro-growth agenda. That said, my experience tells me that more often than not, big trend reversals are usually identified through

technical analysis long before the fundamentals can confirm the same outcome.

While the fundamentals still remain weak (see fundamental analysis below), technical price action as observed on the monthly chart of the 10-yr UST has flashed

the first warning signal that the bull market in bonds may be coming to an end. Specifically, in November 2016 we witnessed an upside breakout of a descending

triangle pattern (see monthly 10-yr chart analysis below) that projects that the 10-yr yield should move towards 3.00 to 3.40% over the next few years. Should

this begin to happen, we will breach the important level of 2.70% on the monthly chart (also explained below) and the odds that the bull market in bonds has

come to an end will have increased. Clearly, price action over the next few months will require our full attention because as you can see in my analysis of the

daily 10-yr chart below, I think there is a good chance we trade as high as 2.80% before the end of January 2017, putting us above the important 2.70% level.

As for the Federal Reserve, they are clearly focused on continuing their path towards normalization, although I expect them to error on the side of being slow to

raise rates. My FED outlook for 2017 is that they raise rates at least two times and maybe a third. Likely, no more than that.

Lastly, while I think there is very real possibility that the bull market in bonds in over, I do not think we are going to witness some massive up trade in yields

over the next few years. Rather, I think it is more likely that the 10-yr note will trade predominately between 2.70 to 3.50% for several years to come.

US Economic Outlook / Commentary By: Paul Curtis on January 16, 2017

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Fundamental Analysis – What is it telling us? (See charts below while reading)

Are the fundamentals signaling an end to the 30+ year bull market in bond prices? Short answer is NO, but that could change soon.

Coming out of the 2008 recession, I looked for sustained upward momentum in GDP, non-farm payroll and inflation (as measured by core PCE) as the all clear

signal for the FED to begin aggressively moving towards a normalized FED funds rate (~3.00%). Initially, all of these indicators saw upward improvements

going into 2011, as measured by their 12-period moving average (red line). But, in 2011 the upward momentum of GDP and PCE both flat lined at the anemic

levels of 2.20% and 1.65% respectively and we have remained there since. While non-farm payroll did continue to show improvement, it too eventually stalled

and turned back down and is now currently at a level similar to 2011 (around 200k per month). So from an historical view, the fundamentals clearly do not

support and end to the 30+ year bull market in bonds. Right? Actually, not so fast.

Simply put, should President Trump be successful in implementing many of his pro-growth policies (lower corporate tax rates, hefty infrastructure spend, less

regulation, repatriation of corporate money and retaining and/or bringing jobs back to America), these indicators should begin acceleration higher into 2018.

As an example, a $1 trillion dollar infrastructure spend could easily add about 1% annually to GDP over the next 5 years. Ultimately, this will allow the FED to

safely move towards a more aggressive tightening stance.

From here, I will be paying very close attention to how quickly his pro-growth initiatives are rolled out and handled by Congress. If they are moved through

quickly (very likely), the market will continue pricing the anticipated impact of these initiatives far in advance of the measurable impact.

Below is a brief historical perspective on each of these indicators that will serve as a good baseline against future activity. The grey bars represent prior

recessions, the black line represents a linear regression trend line and the red line represents a 12-period moving average. In looking at the graphs, one can easily

see that all of the indicators have been in a long term decline (black line) dating back to 1959 and the peak activity (red line) following each historical recession

has generally been lower and lower. Given the magnitude that each of these fell during the last recession, we should have gotten a much stronger bounce than we

did.

US Economic Outlook / Commentary By: Paul Curtis on January 16, 2017

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Technical Analysis Update for the UST 10-yr:

Is technical analysis indicating an end to the 30+ year bull market in bond prices? Short answer is NO, but a monthly close above 2.70% will be the first strong

indication that we have entered a long term bear market in bond prices. I am going to break this part of the analysis down into two parts. The first part will focus

on current developments on the monthly 10-yr yield chart and the second will focus on the daily 10-yr chart.

Monthly 10-yr Chart Analysis (Yield) (see chart below while reading)

Dating back to the 1980s, the 10-yr US treasury rate has been trapped in a declining pattern that has been well defined by a 2 standard deviation lines on either

side of a linear regression line. Over this time period, observed market rates have predominately traded inside of lines. However, an eventual breach of the

upper line would likely mark the beginning of a long term bear market in prices (higher yields). While we have not yet breached this line, a recent technical

development on this chart projects that we soon will.

In November 2016, we witnessed an upside breakout of a descending triangle that began forming back in 2013. From the breakout level of 2.01%, the pattern

projects an additional rise of 1.0 to 1.4% from the breakout level or a terminal yield of ~3.0 to 3.4%. Because we must consider time along with price, this

pattern should unfold over the next 3 years. Should this occur, we would clearly be well above the upper regression band (currently 2.70%) confirming the start

of a long-term bear market. Further, as time moves on it will take an even lower yield level to re-enter the upper band (ie: level drops to ~2.12 in early 2019).

US Economic Outlook / Commentary By: Paul Curtis on January 16, 2017

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Daily 10-yr Chart Analysis (Yield) (see chart below while reading)

The explosive move up in yield following the Presidential election looks a lot more like the trade of 2013 as opposed to other up in yield trades that have

occurred since 2011. Historically, the 2.37 to 2.45% area on the UST 10-yr yield has proven to be an area of significant upside resistance from which the market

has proceeded to quickly turn back lower in yield. Since 2011, we have traded up to the 2.40% level six other times, in five of these cases the market quickly

retraced lower. The sixth case was back in 2013 when we blew right past 2.40% and traded all the way up to around 3.00%. In this most recent case, the move

right through the 2.40% area points to an inevitable move towards 2.80%.

In 2013, the first leg up in yield occurred over about 37 trading days for an increase of about 1.04% in yield. In 2016, the suspected first leg up in yield occurred

over about 42 trading days and resulted in yields climbing about .95%. In 2013, there was a second leg up in yield after a 7 week period of consolidation which

included a .20% drop in yield before yields ultimately climbed ~.50% over a 3 week period. In 2016, following the suspected first leg up in yield, we have seen a

similar period of consolidation (fast approaching 7 weeks) with a similar retracement of about .20% from the high. Given what has already occurred on the

monthly chart (break of triangle pattern), I would be very surprised if we did not see a move towards 2.80% over the next 3-4 weeks.

US Economic Outlook / Commentary By: Paul Curtis on January 16, 2017

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Strategy:

While it is always difficult to identify major turning points in market direction, particularly when then trend has been in place for 30+ years, it pays to keep a

keen eye for what may await around the corner. Given the recent upside breakout of descending triangle pattern as seen on the monthly 10-yr rate chart coupled

with the eerily similar pattern (to 2013) that has developed on the daily chart and the potential for a flurry of pro-growth stimulus plans being announced, we

must not be complacent and expect interest rates to just resume their long-term path downward.

In the short-term, while 2.70% could present some resistance, we could easily see 10-yr price action blowing right through that level and up towards 2.80% over

the next several weeks. From there, we would like trade back towards 2.70% and consolidate again before moving up towards 3.00%. The key now, it to watch

for a monthly close above 2.70% which would be the first real confirmation that the bull market in rates is likely over.

At this point, it would take a weekly close below 2.18% for me to even consider that the break on the monthly chart could represent a false breakout. Therefore,

it seems prudent to lighten up on duration as I believe the next leg up in yield is about to occur sooner rather than later. If you need to add duration, I would not

consider adding until we trade up to at least 2.80%.

Longer term, expect the 10-yr treasury yield to settle into a 2.70 to 3.50% area over the next several years.