Interest Rates in Play

Stronger than expected employment numbers pushed interest rates higher this morning with the 30-year rate exceeding 4.25% and the 10-year rate pushing to 3.50%. The 30-year rate's next target appears to be 4.43%, recorded exactly one month ago on November 4th. A move above this level could result in a real interest rate surge.

PERCEPTION IS EVERYTHING

One only needs to look at the stunning surge in gold prices to see the potential for a dramatic interest rate move. Gold surged over 20% in less than 2 months, bouncing off the $1,000 level to over $1,200. Although the US Dollar was continually weakening, the strength of the gold move overwhelmed that of the dollar. The gold move grew legs of its own as higher prices always brings in more buyers. With so much money out there and the market very well set on continuing lower interest rates - remember, the FEDERAL RESERVE said that they will keep interest rates low for the foreseeable future - a great many of market participants are positioned according to Fed-Speak. But sometimes, the market is just TOO BIG. Bigger than Ben Bernanke. What happens if rates shoot up 20%? What will the reaction be then?

Will the charge turn to higher rates? What will happen to all the countries and institutions that are heavily invested in intermediate and long-term US bonds? Is this why the government pushed the Accounting Standards Board (FASB) to discontinue mark-to-market accounting for banks? Banks and other institutions heavily invested in longer-dated treasuries would be devastated and another banking crisis would again arise!

AND THEN WHAT??

And then what if China, Saudi Arabia, India and other countries start seeing huge losses on their bond holdings? Will they be sellers or buyers? How much more debt would the government need to bring to market to pay the higher interest rates? ARRGGHHH, how easily things could spin out of control. As you can see, the Federal Reserve and US Government will do everything that they possibly can to keep interest rates low. A surge in interest rates could potentially break the US. It is what many economists fear the most.

The question even came up yesterday in Federal Reserve Chairman Bernanke's reappointment hearings. He was asked about Dr. Roubini's (Dr. Doom)previously correct forecast that the US would having the housing crisis and his current prediction that Federal Reserve actions will result in just what I have been discussing here. Bernanke somewhat dismissed Roubini's forecast as being based on a poor economy while Bernanke was confident that his actions during the recent market meltdown, saved the economy and we are now on the uptick.

It was interesting to note that one Senator reviewed many of Bernanke's previous assurances about the housing crisis and other economic calamities. All the way to the end, Bernanke assured congress that there is no danger of a market collapse. Also interesting was that many of the senators complained of how the Fed and Treasury appears to be in a culture of rewarding failure instead of punishing it. In the case of Bernanke, it was clearly evident that he had failed in his first term to achieve any of the goals he set when he was appointed as Fed Chairman. Yet, congress will again reward failure with a second term. It's clear the the pattern of failure starts with the government. As failures continue to be rewarded and problems get glossed over instead of corrected, I am confident that in the end, interest rates will explode to the upside and the stock markets will collapse as a result.

LEARN HOW TO HEDGE

In the course of this blog, we have discussed methods of playing interest rate movement including ETFs, Futures and Options. A simple way to play rising interest rates with a bit of leverage is with the Ultra Short 20year + bond ETF (TBT). Review earlier writings to learn more about it and what I've been doing with this instrument.



As interest rates again start to look interesting, and we approach the new year, I will again be trading interest rate futures and options and will be discussing my ideas here. You can also see what I am doing in real time by reviewing Interest Rates Trading Results .

Many Expecting Interest Rate Rise

Interest rates are on the rise! Ten-year treasury rates are once again breaking through the 3.5% level while the longer termed, 30 year rate is breaking to new recent highs at 4.33%. With additional supply hitting the market this week, many are concerned that interest rates must rise soon either through market forces or by the Federal Reserve signalling that it will soon begin raising rates.

Many experts say that the 0% rate set by the Federal Reserve was a good policy when the markets were crashing and the Fed needed to implement emergency measures. It is now clear, with stock markets up significantly from their lows, that we are not in a panic mode any longer and rates need to rise. Most believe that the Federal Reserve was responsible in a large part for the past bubbles including the High Tech bubble and Housing bubble. Both which led to stock market crashes. By keeping rates so low again, new asset classes are reaching bubble levels. Low interest rates have led to a weakening dollar and very high commodity prices. Despite a weakened economy, the price of oil is again above $80 and many believe that soon it will be well above $100. It's not that there is demand for it, since oil is priced in dollars, as the dollar weakens, prices of oil, gold and other commodities rise to compensate for the lower dollar. The Federal Reserve could cause the dollar to strengthen by raising interest rates.

As mentioned before, the Ultra Short 20 Year+ Exchange Traded Fund (symbol:TBT) rises when interest rates rise. Since many hold both stocks and bonds in their portfolios, and both stocks and bonds have been rising, they need to consider ways to protect themselves when the markets fall. Without prudent money management and risk control, investors could find themselves watching their life savings dwindle.

Last week's action in TBT might have been a three week test of the low and a reversal, breaking through the trend line. If we are in fact establishing a base here, one could expect TBT to test the 60 level again. A break out of this level can lead to significantly higher prices.

Interest Rates May Surge

Interest rates along with the stock market backed down today after Treasury Secretary Geitner expessed continuing concern over the financial recovery. Notice in the chart above how interest rates fell back nicely to the moving average and appears to be positioned to break out to the upside.

In previous writings, we illustrated how rates could surge to 3.6% by early June. Sure does look like a good possibility from these levels. Last week, I was unsure that rates could hold this channel. I have not expressed any confidence in this government-engineered spurt in the market. The bottom line is the continual devaluation of the dollar and increased debt issuance keeps us positioned in our core stock market portfolio with ultra short dollar and bond positions. Government intervention in the 10-year and 30-year treasury market is always a threat for our short-term derivatives positions. It was best to remain cautious.

The daily chart looks like we can expect a pop in rates tomorrow. Position yourself appropriately.,