Friday, January 22, 2010

Interest Rates Poised for Big Move Up

The other day, I was reviewing the potential for a reverse head and shoulders formation building up in the 10-year interest rate. It appeared that a breakout through the 4% level would lead to a move up to the 6% rate. Over time though, we can see that there has been a very strong persistance for rates to move lower. Has this been the Greenspan work? Keep rates down at any cost? Rates will probably have to move up on some powerful economic force to get through the 4.5% level illustrated by the dark trend line that I added. The move will likely be swift and persistent, perhaps some news out of China? Perhaps the demise of Bernanke? A huge move in the dollar? Whatever it is, the market could be setting up for it.

Notice the weekly chart of the 30-year rate as well. Look at this huge bottoming formation!

We did break out to the 5% level last year, a sort of "test the waters" move. Rates quickly fell back though but held support on the rising moving average line. We have continued to find support on the rising moving average line. We are quickly running out of room between support and resistance. SOMETHING HAS TO GIVE!

If you don't pay attention, you may find yourself getting killed in your diversified investment portfolio. Consider that rising rates result in lower bond prices, thus your "conservative" portion of your portfolio will be under stress. You should review this situation with your investment adviser as soon as possible. While many advisers will avoid making "tactical" moves, how you position the fixed income portion of your portfolio is very important. The longer the duration of your fixed position, i.e., going out 20 to 30 years, the more volatile your bond prices will be. Shorter termed instruments have less volatility because they will mature at par in a shorter period of time. When you are facing rising interest rates, you want to have shorter-termed fixed income maturities to avoid volatility. If you believe that rates will rise sharply, you might even want to be in cash and then systematically put it into the fixed income instruments yielding higher rates.

If you are really aggressive and want to hedge your fixed positions or even play the rising interest rates, instruments such as the ProShares Ultra Short 20+ bond ETF (TBT) is one way for the average person to participate. For each 1% bonds go down, TBT goes up 2%! If you are a real player, futures and options on futures are the way to go. See what I am doing in this arena at Current Interest Rate Trades

Be careful about your stocks as well. The market has been rising steadily as low interest rates and dollar liquidity has forced dollars into investments across the board. Higher rates are likely to cause the bubble to burst on the equity market as smart money will take their huge market profits and park it into higher interest rates. This is certainly not the time for the "faint of heart." If you don't have an investment adviser and are trying to do it all on your own, you may find yourself getting pounded once again and doing the wrong thing at the wrong time.

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