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.

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.