Monday, January 4, 2010
After a decade long decline which included a phenomenal blowoff last year pushing the 30-year rates down to the 2.6% level, longer-termed interest rates appear to be headed much higher in 2010. While monthly demand continues to appear strong at the auctions, foreign countries, especially China, have made it clear that they are unhappy about financing the U.S.'s recovery.
While it is clear that China has been seeking ways to diversify away from the U.S. Dollar, any significant slowdown in their purchases could have a huge affect on interest rates, regardless of what the Federal Reserve and Treasury try to do to keep rates low. Higher rates would also require even more U.S. borrowing to support their burgeoning deficit. Soon the Congress will be voting again to raise the debt limit even higher. It sure does seem silly to even have a debt limit when they routinely raise it.
While the very long-term trend on rates is down, low rates are truly fiction. In a free, unmanipulated market, rates would be much higher. Eventually, they will have to rise no matter what happens in the economy. Should the economy strenghten, then surely rates will rise to reflect the demand for money. But even a weak economy can evenutally hurt as dollar flows to foreign countries continue to decline, leaving fewer dollars available to buy treasuries.
It's fortunate that there are now instruments available to play this potential move. I had been expecting higher rates since 2005 and frankly, the futures market just doesn't appear to be the most efficient way to play such a move. But ETFs such as the ProShares Ultra Short (TBT) instrument continues to be my favorite way to play.
After climbing more than 30% in 2009, I continue to hold TBT and include it in all of my managed portfolios.