Talking Numbers

What cigarettes can tell us about interest rates

What cigarettes can tell us about interest rates

A funny thing happened on the way to the taper: bonds rallied.

Since the Fed told the world it would pull back on its stimulus program– a process known as the taper– bond yields have actually fallen (rates and prices move inversely to each other). Federal Reserve Bank chair Janet Yellen is expected to announce further tapering of its bond-buying stimulus program when the Fed meets Wednesday. And yet despite the move, some traders see traders heading lower.

(Read: Treasurys rise ahead of Fed announcement, data)

"I actually think that yields should head lower, meaning bond prices move higher," said Richard Ross, global technical strategist at Auerbach Grayson.

Ross calls the price action since February on the 10-year U.S. Treasury Note "a range within a range." The larger range began in June of last year and is between 2.5 percent and 3 percent. The narrower range – roughly between 2.6 and 2.8 percent – has been in place since January.

"What that tells you as a technician is that the volatility is contracting," said Ross, a "Talking Numbers" contributor. "Ultimately, that volatility will have to expand out of that range. When it does so, it will unleash that energy and it will move strongly in the direction of the breakout. I think that breakout will be to the downside and I think that rates will get weaker."

The catalyst will be a flight to safety, according to Ross. "Equities will be sold, bonds will be bought, and yields will move lower regardless of this Fed policy," he said.

Steve Cortes, founder of Veracruz TJM, agrees with Ross that interest rates are headed lower. One of his signals, though, comes from a surprising source: tobacco stocks. Altria is trading near its 5-year highs while Reynolds American and Lorillard are at their all-time highs.

(Watch: Faber Report: Tobacco consolidation coming)

"Those are very high dividend-paying stocks," said Cortes. "Typically, high dividend-payers do very well in a low-rate environment."

Cortes also noted that the ETF tracking the S&P utilities sector, the XLU, is also at all-time highs.
"Stock investors are telling us they expect yields to stay low for a long time," Cortes said. "Normally, those kinds of moves in tobacco and utilities presage lower rates on 10-year yields."

The market's third "tell" of which way interest rates are headed comes from payroll processors, according to Cortes. With wages relatively flat and economic growth in the low single digits, Cortes doesn't see inflation pressures requiring higher interest rates any time soon.

"I've been watching very closely Paychex (PAYX), a key payroll processing company," Cortes said. "Paychex has not done well lately. That doesn't bode well for employment, which doesn't mean inflation, which means continued low Treasury yields."

To see the full discussion on what's next for Treasury yields, with Ross on the technicals and Cortes on the fundamentals, watch the above video.

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