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.

The Twisted Logic of the Fed's New Policy Move

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.

At the end of its September two-day meeting, the Federal Reserve announced it latest attempt to revive  the U.S. economy -- Operation Twist. This Fed launched its first program to stimulate the economy four years ago at its September 2007 meeting and the economy is still in the doldrums. While the Fed hasn't yet begun QE III, the Bank of England looks like it is about to return to this form of money printing.

The Operation Twist announcement didn't come as a surprise to the markets. It was obviously leaked to the press days ago and articles about it were common in mainstream news outlets earlier this week.  The name comes from a dance popularized by Chubby Checker in the early 1960s -- the last time the Fed engaged in a similar policy move. The rotund Mr. Checker is an appropriate symbol for the bloated U.S. national debt,  the bloated U.S. budget deficit and the bloated Federal Reserve balance sheet, which has been swollen by huge amounts of money printing. The Twist itself involves expending lots of energy going back and forth, but getting nowhere -- the very picture of the 2011 Fed.

In the current Operation Twist, the Fed is planning on selling $400 billion of short-term debt and buying treasuries with 6 to 30 year maturities. The idea is to drive down longer-term interest rates in order to stimulate the economy. Many mortgage and credit card interest rates are set based on the yield of the 10-year U.S. government bond. The 10-year interest rate is already at a record low after falling below the low of 1.95% established 70 years ago in 1941. Real U.S. interest rates (those adjusted for inflation) have been negative for some time. Thirty-year and 15-year fixed mortgage  were already at their lowest historical rates earlier this month. There is no evidence that interest rates are holding back consumers from making purchases. Lack of jobs and income are the problem and the Fed's latest move isn't likely to improve either.

Across the pond, the Bank of England looks like it will start another round of QE (quantitative easing) later this fall. The BOE already printed 200 billion British pounds in 2009 and 2010 for its initial program. This is small compared to the $2 trillion increase in the U.S. Fed balance sheet.  It is universally acknowledged that the UK economy is weakening and the BOE is willing to take this risky inflationary approach even though British consumer prices have increased by 4.5% in the last year. Real interest rates are negative there as well.

The Fed is probably anxious to start its next round of QE as well, but political pressure is holding it back.  Republican leaders in congress sent a letter to Ben Bernanke to "resist further extraordinary interventions in the U.S. economy". Apparently, they are worried that money printing and negative real interest rates will lead to serious inflation -- just as they always have throughout history. The anemic Operation Twist certainly isn't in the category of extraordinary. If anything, it's sub-ordinary. Apparently the stock market thought so with the Dow Industrials falling 284 points or 2.5%, the S&P 500 down 35 points or 2.9% and Nasdaq closing 52 points or 2.0% lower.


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.