Bidirectional U.S. Stocks, Spanish Bonds and the ECB

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

The new mantra for the U.S. markets appears to be "if it's Tuesday, it must be bidirectional market day".  Once again the Dow went up strongly, while the Nasdaq was trading in negative territory. Events in Spain seem to be connected with this unusual and bearish market action.

At one point during the trading day, the Dow Industrials were up 123 points. Nasdaq on the other hand was down by 20 points at its worse. The S&P was caught in the middle. The same strange behavior took place last week. Spanish bonds and the euro rallied both times and money pumping from the ECB (with perhaps some dollar swap activity from the Fed) explains these seemingly unrelated events.

The yield on the 10-year Spanish government bonds exceeded the dangerous 6% level last week and suddenly heavy buying came in and drove yields back down to around the 5.86% level. Today, the yield on the Spanish 10-year reached 6.049% and suddenly buying came in and drove the yields down to 5.86%. The Euro rallied both times. As measured by the ETF FXE, it rose to 131.19 today. There is no reason investors should be buying either one. Spain is at risk of developing a full-blown debt crisis just like Greece and the Dutch government fell and the French election went badly over the weekend.

Money pumping causes markets to rally. It is directly being aimed at the Spanish bond market and the euro however. It spills over into other markets though. Since the Dow consists only of very liquid big cap stocks it will be impacted the easiest. The rest of the U.S. market has serious problems though. Tech stocks have led it up and now they are struggling. The ECB money pumping isn't enough to counteract the forces driving them down.

Money pumping can't go on forever and every time there has been a pause, stock prices have suffered. Problems in Spain are merely part of a much larger ongoing debt crisis in Europe. The balance sheet for the ECB has already been increased by much more than has been the case in the U.S. and the chart line is going straight up. A pause will eventually take place and when it does stocks will weaken globally -- and this includes the Dow.

Disclosure: None

Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.

Interest Rates Spike on News From Banks

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

While the big Tuesday rally in stocks got all the media attention, the big selloff in U.S. Treasuries that accompanied it went largely unnoticed. Good news for banks apparently means much higher interest rates and bad news for consumers.

Yields on U.S. treasuries were not that far above historical lows before the boondoggle accompanying the Federal Reserve's stress test announcements. When JP Morgan jumped the gun and other banks followed on March 13th, stocks mounted a spectacular rally in the last hour of trade. No one asked however where the money to fund all of that stock buying was coming from. Even a casual analysis shows that it came from the selling of U.S. Treasuries (which continued into the next day). 

The two-day rise in yields from the bond selloff was sizeable to say the least, with the longer-end of the curve having the biggest gains in absolute terms. Yields were up 26 basis points on the 30-year, 25 basis points on the 10-year, and 26 basis points on the 7-year (a basis point is one hundredth of a percent). Even the 5-year yield rose 21 basis points. Essentially, interest rates rose a quarter of a percent on treasuries with maturities of 5 years or more — and it all happened literally overnight. 

Since interest rates were at such low levels, the spike in yields represented a big increase on a percentage basis. This was most pronounced at the middle part of the curve. Yields on the 7-year went from 1.43% to 1.69%, for a gain of 18%. Yields of the 5-year went from 0.92% to 1.13%, and this represented a 23% increase. An even bigger jump took place in the 3-year, with yields up 28%when rates rose from 0.47% to 0.60%. The two-year though was up only 18% after going from  0.33% to 0.40%. The percentage increase in the 10-year, where yields went from 2.04% to  2.29%, and the 30-year, where yields went from 3.17% to 3.43%, were modest in comparison.

Treasury bills were less affected with yields on the 3-month and 6-month unchanged. The one-year rate rose from 0.18% to 0.21%. The one-month yield (which went negative in late 2008 and late 2009) went from 0.05% to 0.08%.  Yield information for treasuries can be found at: http://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield.

The Fed's Operation Twist, a plan to sell $400 billion of shorter-dated Teasuries and buy an equivalent amount of longer-dated paper is still ongoing. By the end of March, a switch of $268 billion will have taken place. The purpose of this operation is to keep rates for the 10-year yield low in order to stimulate the economy. Apparently, it wasn't working so well this week. The Fed publishes the schedule for its Operation Twist sales and purchases and these can be found at: http://www.newyorkfed.org/markets/tot_operation_schedule.html.

The rise in interest rates is not just important to investors, but to consumers. as well. Consumer loans are frequently based on some formula using the 10-year Treasury yield. If this goes up a quarter of a percent, so will the rates on consumer debt. This will be a drag on the economy. While rates have been kept artificially low by the central bank for the last three years (they have gone down during the "recovery", when they should have been going up), the sudden rise in yields this week indicates the Fed may be losing its ability to hold them down.

Disclosure: None

Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.

10 Reasons We Are in a Credit Crisis

 

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

Yesterday's news was about a potential Greek default and it caused a global market selloff. Today,  hopes of preventing a Greek default are causing markets to rally. This alternating news flow is repeating over and over again. Investors should pay attention to the big picture however and not the noise of the day. The important thing to realize is that we are in a second global credit crisis.

Credit crises follow certain patterns, which include: recognition of overpriced financial assets, money flowing into safe havens, increased market volatility, rising costs for financial insurance, and various forms of government action to stop the problem. The specifics of the current credit crisis are below.

1. Government debt is being downgraded. This happened in Italy yesterday, the U.S. in early August and many times in Greece. This is the upfront recognition of the problem, which is almost always widespread public knowledge by the time it happens. In 2008, securitized debt containing subprime real estate loans was downgraded in mass, frequently from the triple A ratings that had previously been given.

2. Global money is flowing into safe haven U.S. treasuries. When yields hit lower levels than a previous credit crisis or all-time lows, this indicates this is happening on a mass scale. U.S. government two-year notes had a yield below 0.15% at one point this September 19th. During 2008, the two-year held above 0.60%. The ten-year yield has fallen below the 2.04% low in 2008 and below the all-time low of 1.95% in 1941.

3. Global money is flowing into safe haven currencies. In 2008, this was the U.S. dollar and the Japanese yen. In 2010, this is the Japanese yen, the Swiss franc, and gold (which needs to be thought of as a currency if it is to be analyzed correctly). The Swiss franc rallied so much that the Swiss stopped it from trading freely. The Japanese have also taken action to try to lower the value of the yen.

4. Stock market volatility has increased enormously. In 2008, there were a significant number of mini-crashes (a drop of 5% or more in one day). These were more common in the U.S. back then. Now they are more common in Germany, but they have been happening here as well. The flip side of mini-crashes is sudden sharp moves up in the market. These are also occurring.

5. Bank stocks are the focus of the big moves up and down in the stock market. U.S. banks and other financial stocks really got hit in 2008 -- a number of the companies themselves went under. This time it's European banks falling the hardest. One-day drops for some major EU and UK banks have been as high as 10%. Bank stocks aren't dropping that much in the U.S., but they are underperforming other sectors like technology.

6. Credit default swaps have hit record levels. Credit default swaps (CDSs) are bond insurance and they became a big news item in 2008 when they rose to unprecedented levels. While CDS rates for Greek sovereign debt have hit records and are rising for the other highly indebted EU countries, they have also hit records for some UK and EU banks in 2011 indicating a worse crisis than in 2008.

7. Major and ongoing bailouts are taking place. The EU had to bail out Greece in the spring of 2010 and then Ireland and Portugal. A second bailout for Greece had to be arranged this July, even though the first bailout was supposed to have taken care of Greece's debt problem. In 2008, the U.S. had TARP and arranged for failing banks to be taken over by stronger banks  (Bank America is now in trouble again because of the legacy loans from the banks it absorbed during this period). Fannie Mae and Freddie Mac had to be nationalized. 

8. Central banks are buying bonds in the open market. The EU has been buying up Italian, Spanish, Irish and Portuguese bonds in order to hold down interest rates in those countries. As long as it has an infinite access to funds, this strategy will work. The Fed began buying U.S. debt instruments in the fall of 2008 during the Credit Crisis. 

9. Global coordinated central bank intervention took place last week. The need for global action is a consequence of the interconnectedness of the world financial system. A major problem in one region (in 2011 this is Europe, in 2008 it was the U.S.) will invariably spread everywhere. Central banks coordinate their activity to try to control the contagion. 

10. The global economy is turning down.  Problems in the financial system impact the real economy and they can turn a shallow downturn into a major one as has happened in 2008. Economic figures throughout the world have flattened and there are some warnings of a bigger drop to come (extremely low consumer confidence numbers for instance). GDP contraction in a number of regions will be the final confirmation that another global credit crisis has occurred. 

Disclosure: None

Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.

Interest Rate Spread Widens as Greece Heads Toward Default

 

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

Global interest rates continue to diverge, with rates rising in the troubled eurozone countries and falling to new lows in Germany and the United States.  The same sort of divergence took place during the 2008 Credit Crisis with yields on safe-haven governments falling markedly, while yields on low-grade corporates soared.

Nowhere in the world is the current interest-rate spread more extreme than in the Eurozone (the epicenter of the current credit crisis). Greece is leading the pack with ever-rising yields on its government paper, while German rates keep falling. In Tuesday morning trade, two-year Greek government yields reached a high of 74.88% and ten-year yields a high of 25.01%. Yields on German 10-year bunds were moving in the opposite direction falling as low as 1.679%, even lower than Monday's record-low rate of 1.877% on 10-year U.S. treasuries.

Italy had an auction of 5-year bonds this morning and had to pay a 5.6% yield to get them out the door
compared to 4.9% in July.  Interest rates on the Italian 10-year were at 5.75%. They were over 6% before the ECB started buying Irish, Portuguese, Spanish and Italian bonds on August 8th to force down surging rates as contagion from Greece spread to other parts of the Eurozone. Before that, yields in Ireland had reached approximately 14%, they were over 13% in Portugal, and in Spain they were at similar levels to Italy. Intervention can only maintain below free market rates for so long however. Eventually, the ECB will run out of funds.

The trajectory of Greece's decline toward insolvency is instructive for the future of Ireland, Portugal, Spain and Italy in the near future and for other highly indebted countries such as Japan, the United States and the UK later in the decade. In early 2010, Greek 10-year rates spiked above 12%, but were then driven below 8% with the first bailout. Greece had a debt to GDP ratio around 120%. Severe budget cutting was implemented to hold the debt down. This caused the economy to contract sharply, which lowered tax revenues. Despite the first and now a second bailout a self-feeding spiral of ever-increasing interest rates began. Higher interest rates and a weakened economy have caused the debt to GDP ratio to reach the 140% level (according to official numbers, estimates are as high as 160%). Rates on credit default swaps now indicate a 98% chance of default.

What the immediate effects of a Greek default will be remain to be seen. There will certainly be damage to the Eurozone banking system, which is still in a weakened state from bad loans accumulated before the 2008 Credit Crisis. At some point, the euro will have to be restructured or
it will be weakened considerably. Economic damage will not be limited to Europe, but will affect other regions of the globe just as was the case in 2008.

Disclosure: None

Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.

EU-Centered Credit Crisis Continues

 

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

The 2011 Credit Crisis continued Tuesday with the Stoxx Europe 6000 index hitting a two-year low, the Swiss taking desperate measures to control the franc, more record high prices for credit default swaps (bond insurance) on British Banks and yields on 10-year U.S. treasuries hitting an all-time low. Despite the dramatic turn of events, stock losses were somewhat muted.

U.S. markets opened sharply lower, but the Nasdaq and S&P 500 recovered toward the close in a technical move that involved filling the gap down that took place on the open. The Dow however still had a 101 point loss at the close. In Europe, the German DAX was down 1.0% and the CAC-40 in Paris 1.13%. While these losses would have been considered significant only a few months ago, they are minor compared to what has taken place on a number of trading days since late July. The British FTSE up even up 1.06%, despite trouble in the UK banking sector.

The British banks most in trouble are the ones that were nationalized during the 2008 Credit Crisis -- Royal Bank of Scotland and Lloyd's Banking Group. Credit default swap (CDS) rates for these banks are higher than they have ever been. CDS rates for HSBC and Standard Chartered are at one-year highs. The problem with these banks seems to be toxic loans left over from earlier in the 2000s. It is not clear if they were included in a sweeping statement made Monday by Josef Ackermann, CEO of Deutsche Bank, that "numerous" European banks would collapse if they were forced to recognize all losses against their holdings of government debt.   

The most significant market event yesterday was the Swiss capping the value of the franc. The Swiss National Bank (SNB) said it would "no longer tolerate" a euro franc exchange rate below 1.20. The franc then had a significant drop against all major currencies. A similar approach was tried in 1978 and it did succeed in stabilizing the franc back then. Such currency intervention measures generally only work for a short time however. It remains to be seen how long it will take before the franc begins rising again.

The new Credit Crisis is also showing up in U.S. treasury rates just as the one in 2008 did.  The 10-year yield made another all-time low at 1.97%, taking out the 2008 low. Global money flows into U.S. government bonds during periods of financial system instability because they are still seen as safe havens. While the 10-year is only a little below its low in 2008, the two-year at 0.20% on Tuesday is well below its low point back then.

Credit Crises are not very short events. The previous one lasted six months. This one could last that long or even longer. The cause of the problem has to be gotten under control. In this case, it is the ongoing debt crisis in Greece and the emerging ones in Italy and Spain. While a default in Greece could happen this fall and create some finality there, the problems in Italy and Spain are only in their early stages. So, this could go on for some time.

Disclosure: None
Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.

Should Stocks be Rallying on Hopes of QE3?

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.  


Stocks have rallied significantly since August 10th on the hopes that the Federal Reserve will engage in a third round of quantitative easing (QE) -- a form of money printing. While QE1 and QE2 were successful in juicing stock prices, this is not what the Fed is supposed to be doing.

The Fed's current mandate was established by the U.S. Congress in 1977 in the Federal Reserve Reform Act. This legislation requires the Fed to establish a monetary policy that "promotes maximum employment, stable prices and moderate long-term interest rates". Manipulating stock prices is not supposed to be on the Fed's agenda. Quantitative Easing was unknown in 1977 and was therefore not specifically addressed by Congress.

If anything,the Fed has significantly overshot in its goal to keep long-term rates moderate. The Fed Funds rate has been kept at around zero percent since December 2008. The Fed has stated it will maintain this rate until 2013. The interest rate on the 10-year treasury fell below 2.00% at one point this August -- a record low. Two-year rates fell below 0.20%, also record lows and well below the bottom rate during the Credit Crisis. Low interest rates indicate an economy in recession and not deflation as is commonly claimed in the mainstream press. Maintaining interest rates at a low level for too long is inflationary however.

The Fed announced its first quantitative easing program in November 2008 (according to an analysis of its balance sheet, it was begun somewhat earlier). The second round ended this June. How has the employment situation changed during the two rounds of QE?  When QE1 started in November 2008, the official U.S. unemployment rate was 6.8%. When it ended in June 2011, it was 9.2%. The high was 10.1% in October 2009. The post-World War II average has been 5.7% and unemployment has fallen to the 3% range when the economy is strong. With respect to employment, quantitative easing seems to have been a failure.

So what about price stability, the Fed's other mandate? While the inflationary effects of quantitative easing are most evident in commodity prices, the typical American consumer has seen them in gasoline, food and clothing prices. The average price of gasoline was as low as $1.60 a gallon when the Fed started QE1 and it almost reached $4.00 a gallon during QE2. A number of commodities, including cotton and copper, hit all-time record-high prices during QE2. Gold, the ultimate measure of inflation,rose to one new price high after another. Silver went from under $10 an ounce to over $48 an ounce. Quantitative easing obviously hasn't led to price stability. In fact, it has resulted in much higher prices and is therefore counterproductive to the Fed's goal of limiting inflation.

There is no question that quantitative easing has helped the stock market and resulted in higher stock prices. This is not exactly a secret however and all Wall Street traders are well aware of it. They will therefore push stock prices higher if they think more quantitative easing is on the way and much of any rally that results will occur before it even takes place. Quantitative easing is also no panacea for stock prices. It doesn't insulate the market from external shocks. While it doesn't make crashes more likely, it will make them worse when they occur. A default on Greek, Spanish or Italian debt and any number of other crises will have greater impact than they would have ordinarily because the market has been pumped up to artificially high levels. The market has also become dependent on quantitative easing and has not been able to rally since late 2008 without it. Almost as soon as it stops, the market drops and those drops will become more serious after each succeeding round.

Disclosure: None

Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.

Three Crashes and a Second Credit Crisis

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

The tech heavy Nasdaq and small cap Russell 2000 crashed again yesterday, August 18th. Nasdaq was down 131 points or 5.22% and the Russell 2000 was down 42 points or 5.90%. This is the third crash for both of them since the beginning of the month. Repeating crashes (drops of 5% or more in one day) were  common during the Credit Crisis in the fall of 2008 and indicate severe stress in the global financial system.

As in the fall of 2008, bank stocks are leading the way down. The only difference now is that bank stocks in Europe are getting hit the hardest, whereas it was U.S. and UK banks three years ago. So far, U.S. markets are holding up better than those in the EU. The Dow and S&P 500 have had only one mini-crash so far. The German DAX has had several. While continental European markets have been hit the hardest, Asian markets have continued to suffer the least from the current turmoil. The Hong Kong markets are being more impacted than those in Japan.

While U.S. banks Morgan Stanley and Wells Fargo were down somewhat more than 4.5% yesterday and Bank of America and Citigroup 6.0%.  This was much better than the 10% drop in Germany's Commerzbank, the 11.5% drop in the Britain's Barclays and the 12% drop in France's 

Société Générale. As of August 18th, the EURO STOXX Financials index was down 38% from earlier this year.

Just last week, French banks were supposedly in trouble, but this was denied by them and one major French news outlet retracted a story that claimed this was the case. Yesterday, the ECB (European Central Bank) said one bank, which it didn't identify, had paid above-market rates to borrow $500 million a day for seven days. Today, it was reported that the U.S. Fed supplied $200 million of liquidity to the Swiss National Bank in the form of forex swaps. These are two separate issues. Switzerland is suffering from a skyrocketing currency (which is going to cause massive loan defaults in Eastern Europe if it continues since many loans there are denominated in Swiss francs), whereas the ECB is trying to keep banks afloat despite the fallout from the Greek debt crisis.

The chances of a full Greek default  (a selective default with bondholders taking a 21% haircut was already part of the second bailout deal reached in July) intensified on Thursday. Finland insisted that Greece provide a cash deposit equivalent to its share of the second bailout guarantees. Four other countries then made similar demands. This of course undermines the bailout by taking away money with one hand that the bailout is providing with the other.

Financial crisis behavior was also evident in the U.S. treasury markets. The yield on the 10-year fell as low as 1.9872 on Thursday, taking out the low from 2008. The two-year treasury has been hitting a series of new lows and has been significantly below its Credit Crisis bottom for some time now. One thing that is different from the 2008 Credit Crisis is that gold is rallying strongly and is in a blowoff. The December gold futures contract hit another all-time high  at $1881.40 this morning before U.S. stocks opened.  Gold has always been a safe haven throughout history and despite claims to the contrary, it will remain so.
Disclosure: None
Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21 
This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Why Quantitative Easing Will Raise Long-Term Rates

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


The two-year treasury yield fell to another record low on Monday, touching 0.3987%. The 10-year treasury yield was up slightly however in September, rising for the first time since March. Federal Reserve money-printing is behind both falling shorter-term rates and rising longer-term rates.

A survey by Bloomberg of more than 60 mainstream economists indicates they expect 10-year treasury yields to keep rising in 2010 and through 2011. Perhaps someone has been passing around some notes on the approximately 500 hundred year old 'quantity theory of money', which states if the amount of currency is increased without an appropriate increase in economic growth, inflation will result (and consequently interest rates will have to rise, with the biggest increase taking place on long-term bonds).  For this not to happen, the laws of simple arithmetic have to be violated. The Federal Reserve has essentially been maintaining that that is what has taken place for the last two years. Bernanke of course does not directly state that we have entered a new economic age where two plus two no longer equals four because he would be laughed out of Washington and even the never questioning U.S. mainstream media wouldn't print such garbage.

Bloomberg also reports that a survey of primary dealers (the people who buy the paper that the Treasury issues) estimates that the Fed will buy $100 billion to $1 trillion in Treasuries by the end of the year. According to Deutsche Bank however, the market has reacted as if $315 billion to $670 billion of quantitative easing has taken place recently. The Fed announced on August 10th that it would be conducting further quantitative easing this year. The stock market then had its best September in seven decades. Money printing is an easy way to juice up stock prices. And since there is an important election on November 2nd, it would make sense to think all or almost all of what is scheduled for 2010 will take place before people vote. It looks like that is exactly what is happening.

While the Fed's actions can make the stock market look good in the short-term (investors need to watch out for what follows however) and can make shorter-term rates like the two-year go down because of all of the buying that it is doing,  longer-term rates will go up if the market sees this as inflationary. The 10-year treasury is the bench mark for everything from home mortgages, to credit cards, to corporate bonds. Higher yields on the 10-year are a drag on the economy. The Fed has supposedly reinstituted quantitative easing to stimulate the economy, although there is little evidence that the Fed has managed to stimulate the economy very much in the last three years. The stimulus has instead come from massive government budget deficits. The Fed seems oblivious to the existence of a liquidity trap, a condition where increased 'money' generated from the central bank just moves around the financial system and never gets into the real economy. Under such circumstances, doing more of the same won't make things any better, but can easily make them worse.

Disclosure: No positions.

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.

Market Says U.S. Treasuries Riskier than Corporate Debt

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


On March 24th, swap spreads on 7-year and 10-year treasuries and their equivalent corporate bonds turned negative for the first time ever. With this move, the market signaled that it thinks that U.S. corporate debt is less risky than U.S. government debt. If so, they will have to rewrite the finance textbooks.

A great deal of financial analysis is based on the risk free rate of return. Risk free in this instance means that default is not possible. This rate is the interest rate on government debt. Technically, sovereign governments cannot default on their bonds because they can simply print the money to pay them off if necessary.  This of course devalues the currency, creates inflation and thereby raises interest rates, which are other forms of risk. Corporations should always have higher interest rates than the country they operate in as long as the country is a sovereign nation and not part of a currency union such as the euro. This is the case because unlike government, corporations can't print money so they can go out of business and their bonds can default. The higher interest rates on corporate debt are needed to compensate for possible bankruptcy. The opposite situation makes no sense whatsoever and indicates that some very odd things are going on in the markets. Nevertheless, more than one market observer noted wryly that the fiscal soundness of many U.S. corporations is actually much better than that of the U.S. government.

The U.S. had a series of government bond auctions last week and they did not go well. Purchases by both indirect bidders, which includes central banks, and direct bidders, which includes domestic money managers, were both down. In the case of the 7-year for instance, indirect bidders bought 42% instead of the usual 50%. Direct bidders bought 8% as opposed to their average 11% purchase. When fewer bonds are bought at auction, primary dealers get stuck with the unsold inventory and then they usually dump it on the market. Bonds then sell off and interest rates go up. The yield on the 10-year rose 15 basis points last Wednesday and peaked at 3.94% on the week, almost as high as last June. Interest rates on treasuries of other maturities rose across the board.

Investors should pay particular attention to the lower demand from central banks and wonder if a lack of purchasing by China is behind this. There is an ongoing struggle between the U.S and China on whether or not China is keeping the yuan dollar exchange rate artificially low. There will be a ruling by the Treasury Department on April 15th on whether or not China is a currency manipulator. Needless to say, the Chinese are not particularly happy about this. China was a net seller of U.S. government bonds in December and January. A significant drop in their buying would cause U.S. interest rates to go up considerably.

Investors should keep an eye on treasury interest rates. The 10-year and 30-year rates have been on the decline since 1980. They now look like they are reversing this pattern and are poised to begin a multi-decade rise in interest rates (and lower bond prices). Shorting treasuries is the way to take advantage of this sea change. Two ETFs, TBT and TMV offer leveraged plays on long-term treasuries (twenty to thirty years) for those who think interest rates are going to rise.

Disclosure: None

NEXT: Questionable Oil Statistics More Accurate than Other Government Numbers

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

The Outlook for U.S. Treasuries

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


Treasuries rallied the last week of February, which should be expected in a strong dollar environment. The rally in the U.S. dollar that started in early December (around the time that news of the problems in Greece began to surface) is ongoing and this will continue to be bullish for U.S. government bond prices and bearish for interest rates while it lasts. Inflation expectations cause the opposite outcome however. These two competing forces help explain why longer dated treasury interest rates have been trading in a bullish pattern since May 2009, but after a brief initial burst upward have traded sideways since that time. Current conditions indicate that a breakout rally to higher rates will probably have to wait a while longer.

In the intermediate and long-term, there are a number of significant risks to U.S. treasuries as well as most other government's bonds for that matter. Direct default is now on the table for smaller economies like Greece. Indirect default through inflation and currency devaluation is the risk for the major economies, such as the U.S., UK, and Japan. Some top mainstream economists, such as Nobel Prize winner Joseph Stiglitz and chief economics commentator for the Financial Times Martin Wolf, have recently made the case that the U.S. can't default on its debt because it owns a printing press. While this is technically true, it doesn't mean the paying back a bond investment with money that is worth much less than it was at the time when it was lent isn't a type of default. Why would anyone want to buy a government's bonds under such circumstances? Bill Gross, managing director at the world's largest bond fund PIMCO, refers to this type of default as stealth-default.  Gross has made the case that the risk of either type of default of government debt will cause government debt and corporate debt to have similar interest rates in the future. This would cause interest rates on government bonds to rise relative to corporates in the next few years.

In the short-term though bad economic news along with the strong dollar should keep U.S. treasury interest rates from rising. There have been a host of negative economic reports in the last couple of weeks on the banking sector, consumers, housing, and durable goods. The ISM Manufacturing Index released on March 1st was a disappointment and its component parts provide an excellent representation of the current push-me pull-you factors on U.S. interest rates. While manufacturing is still in an expansionary mode, new orders and production (indications of future activity) declined sharply and this is a bearish for interest rates. However, the prices paid component, which represents inflation, was the highest number in the February report as it was in the January report. This is bullish for interest rates.  

While the Federal Reserve has frequently announced that U.S. economy is in recovery, it has always followed this up with a statement about how it is going to keep interest rates low for a prolonged period of time. This would not be necessary in an economy that was actually recovering. When the Fed is talking out of both sides of its mouth, investors should pay attention to what it is doing and ignore what it is saying. A prolonged period of low interest rates is inflationary and this means long-term treasury rates will be going up. The only question is when.

Disclosure: None

NEXT: A Snapshot of the Energy Markets

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Why Interest Rates Will Rise in 2010

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

While stocks were rallying, long-term U.S. treasuries were selling off sharply and interest rates climbing on December 21st. The rally was particularly noteable because 10-year bonds were selling down more strongly that 30-years - the opposite of the normal pattern. As part of its quantitative easing program, the U.S. Fed was purchasing 10-year treasuries up to October 31st of this year and this kept their yield artificially low. This trade now seems to be unwinding. Interest rates on consumer loans in the U.S., including mortgages and credit cards, are usually tied to the the 10-year treasury rate. Higher rates will dampen consumer spending going forward and this will be a negative for the economy in 2010. Investors can take advantage of rising rates though by buying ETFs that short longer-term bonds.

Long-term rates need to be examined in context. The yield spread, or the difference in interest rates, between them and short-dated paper provides significant information. The yield spread between 30-year treasuries and the 3-month t-bill has gotten to around 4.50%. This is much larger than normal. The spread was even bigger this June and in 1992. In the last two recessions in the early 1990s and 2000s, yield spreads didn't peak until about 18-months after the recession was over. They already got to those previous peak levels this June, during the recent recession. This indicates that the peak in the current cycle is going to be higher than it was previously. Assuming the current recession ended in July, as would be inferred from government GDP figures, this would indicate that there will be a peak in the yield spread around January 2011. Note that this is not the same as a peak in rates. The spread will narrow if long-term rates continue to go up, but short-term rates go up even faster.

While it looks like long-term rates are going to be higher in 2010, the exact amount is not predictable from yield spread analysis. From a technical perspective, the 10-year treasury will have a significant breakout if its yield rises above 4.00% and stays there. For the 30-year treasury, the key rate is 5.00%. Possible interest rate targets for the 10-year after a breakout are 4.75% to 5.50% and for the 30-year 6.00% to 7.00%. A breakout is not taking place just yet however. As of now, some time in the first couple of months of 2010 looks like the most likely time frame for this to occur. Investors who want to short 7 to 10 year treasuries can buy TBF (100% short), PST (200% short) or TYO (300% short). Investors who want to short 20 to 30 year treasuries can buy TBT (200% short) or TMV (300% short of 30-years only).

A wide yield spread between short and long term bonds is usually cited as an indication of strong future economic growth. Others say it is an indication of rising inflation expectations. Both views can be correct. The pattern is caused by central banks pumping substantial amounts of liquidity into the financial system. This shows up in the economy and inflation at different points in time. Liquidity first pushes up the stock market (we have already seen that), next impacts the economy, and then shows up as inflation. When there is overlap between the economic growth and inflation phases, stagflation results. It can take as much as three to four years for the first wave of inflation to peak. That would take us to at least 2012 in the current cycle - so we have a long interest rate rally ahead of us.

Disclosure: Long TBT and TMV.

NEXT: GDP Revisons Indicate Recession Isn't Over

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Bond Auction Puts Focus On Interest Rates

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

Our Video Related to this Blog:

The U.S. is auctioning off $81 billion in government debt this week. This is just a small part of the never ending supply needed to fund trillion dollar budget deficits as far as the eye can see. The Fed officially stopped its quantitative easing program to buy treasuries on October 31st, so it will be interesting to see what happens to interest rates in the next two or three months. The most vulnerable part of the interest rate curve has always been the 30-year. Foreign central banks have moved their purchases to shorter dated paper and the Fed itself concentrated on buying in the 7 to 10 year range. If the Fed restarts its quantitative easing program (and this is a possibility) it will resume purchases of bonds with those maturities. The 30-year is orphaned without major supporters no matter what happens.

This weeks auction includes $25 billion in 10-years on Tuesday and $16 billion on Thursday. Bonds prices are rallying today (and interest rates going down) even though supply is increasing. This defies free-market behavior and should make it clear that the bond market is regularly highly manipulated in the short term. The Fed notched the usual manipulation up much higher this year however. Figures from the second quarter indicated the Fed bought 48% of newly issued government debt ... and it did so with newly printed money. While the mainstream media has constantly reported that demand for U.S. bonds has remained strong this year, it almost always fails to mention that it is because the Fed is making a substantial percentage of the purchases.

Rising interest rates will be one of the last legs of the inflation trade to kick in because the government has a lot of control over them. The U.S. 30-year interest rate has been in a 27 year downtrend with a yield peak of just over 15% in September 1981 and a bottom last December at just over 2.5%. A rise in interest rates to around 4.8% will break a downtrend line from 1987 (when Alan Greenspan became Fed chair and easy money became the norm for U.S. monetary policy). When 30-year rates can break this level and stay above it, a multi-year rise in interest rates will begin.

In the short term the daily interest rate charts are bullish for the 30-year ($tyx or ^tyx). The 50-day moving average has been trading above the 200-day since last May. Both the 50-day and 200-day are moving up. After the rally from last December to this June when the 30-year rate doubled, the yield fell back to and bounced off the 200-day moving average. So far, this looks like it was the end of the retracement and the perfect buy point. The short-term uptrend is still in place and will remain so as long as the 200-day moving average keeps going up. When it occurs, a decisive break of the 4.8% yield could lead rates up to 6.0%. There are two leveraged ETFs that traders and investors can use to go long 30-year interest rates (the same as shorting the bonds), TBT and TMV. TBT represents a 2X short of 20 to 30-year treasuries and TMV a 3X short of 30-years. Both of these can be highly volatile.

Disclosure: Currently long TBT and TMV.

NEXT: Gold Rumbles as Dollar Crumbles

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Inflation Trade Picks Up

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

Our Video Related to this Blog:

Spot gold traded as high as $1099 yesterday. Gold is the most sensitive of inflation assets and it keeps hitting new all time highs. Spot gold was at $1092.90, up $7.60 at the 5:15PM close in New York. Silver closed at $17.46 up 23 cents. Nymex oil closed up at $80.40 at the end of pit trading. Interest rates rallied sharply with the 10-year and 30-year treasuries reaching 3.55% and 4.43% respectively. The trade-weighted U.S dollar sank, slicing through key support and falling almost a full percent (a big move for a currency). The major stock indices went nowhere, closing flat after giving up all their gains in the last hour with the exception of the small-cap Russell 2000, which closed down 1.3%. Big rallies in inflation-sensitive assets and stocks going nowhere - it's the same story as what happened in the U.S. markets in the high inflation 1970s.

Only the incredibly dull and oblivious could miss the inflation message of the markets. People who live in Washington, D.C. and are involved with the U.S. government in economic policy positions are the most likely to be in this category. The Federal Reserve rarely disappoints. The FOMC (Federal Open Market Committee) concluded its two day meeting yesterday and added the following sentence to their post-meeting statement: "With substantial resource slack likely to continue to dampen cost pressures and with longer-term inflation expectations stable, the committee expects that inflation will remain subdued for some time." The committee also expected there wasn't going to be a subprime crisis and that recession could be avoided months after the recession had already begun (apparently nobody had told them).

When I read this sentence, I immediately pictured someone painting themselves into a corner. The committee is going to have to do some explaining early next year when the inflation numbers start picking up. This statement also indicates the committee members complete ignorance of inflation history. Resource slack is a frequent accompaniment of hyperinflation. Our contemporary example of this is Zimbabwe where unemployment reached 94% and inflation reached the sextillion percent level. In Weimar Germany in the early 1920s, unemployment reached 24% and rose along with the inflation, which reached the trillion percent level.

As we have gone over many times at the New York Investing meetup meetings, the inflation trade consists of the precious metals gold and silver and their mining stocks, energy (oil, natural gas, coal, nuclear and alternative) and their stocks and agricultural commodities. Shorting bonds, which is the same as being long on interest rates is also part of the inflation trade as is getting out of the U.S. dollar and into stronger currencies such as the Australian dollar. Some of these assets will be much stronger or much weaker than the others at different points in time and investment money needs to be shifted accordingly. It will probably takes years before the average investor fully adjusts their investing strategies to the inflation trade assets. In all likelihood, the very last people to do so will be the FOMC members.

NEXT: 'Recovery' Leads to Double-Digit Unemployment

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.

Interest Rates Break Out

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

Our Video Related to this Blog:

Almost everything went down last Friday, everything except the U.S. dollar of course. Continuing the pattern that has been very noticeable since this March, stocks and commodities both retreated as the dollar went up. Looking back at a 10-year chart, you will notice that the stock market and the U.S. dollar used to move together. Somewhere between 2003 and 2005, the pattern changed and they started moving in opposite directions. The pattern actually only became more exaggerated this spring. 2003 was when the Fed lowered interest rates to one percent, which in turn made the real estate bubble take off.

Liquidity is driving this pattern. Liquidity has also made it possible for interest rates to remain low during the last several years. During 2009 however bond prices have only been kept high because the Fed is buying a boatload of treasuries with freshly printed money (note: interest rates go down when bond prices go up and vice versa) while keeping overnight rates around zero. While the Fed has extended its purchase of Agency debt (mostly Fannie Mae and Freddie Mac) until March 31st, it is supposed to stop its quantitative easing program for treasuries on Oct 31st. It remains to be seen how long they will be able to stay out of the bond market. My guess is the printing presses will not remain idle for too long.

Bonds also sold off on Friday. Interest rates bottomed last December, with rates for the 10-year bond falling to around 2.00% and on the 30-year bond to 2.50%. By June, interest rates had approximately doubled to 4.00% and 5.00% respectively. Bonds rallied since then (and interest rates came down). Early this month both the 10-year and 30-year interest rates (not prices) bounced off their respective 200-day moving averages. This was the buy point, although some market watchers claim that 3.48% and 4.30% are the key rates that need to be broken for the 10 and 30-year bonds to be shorted. The 10-year yield closed at 3.48% and the 30-year at 4.29% on Friday, but were at 3.52% and 4.32% this morning - both above their key resistance. To see the interest rates charts on Big Charts (http://www.bigcharts.com/) use $TNX and $TNY for the ticker symbols.

I have already been buying TBT, the 200% leveraged short 20 to 30 year bonds ETF, for awhile now. This has a place at the moment in inflation sensitive portfolios, but should not be a huge position. Silver is my biggest holding and its strength on Friday was impressive. Almost by itself silver managed to buck the selling tide and punch higher. Gold is my next largest holding and I have 200% long silver and 200% long gold in an approximately 60/40 ratio. Mining stocks and the ETF GDX are next. I am trying to move agricultural commodities to become my 4th largest positions and hope to accumulate more GRU on a sell off this week (I already have all the RJA I wish to hold). TBT may wind up in the 6th or 7th place. All of this is likely to change early next year, when I anticipate exchanging a certain amount of my precious metals holdings for oil positions and other portfolio revisions will need to be made.

NEXT: Central Banks Support the Dollar

Daryl Montgomery
Organizer,New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.