|
The following chart shows the yield of the 30-year Treasury bond since January 2007. It’s as clear as crystal that a huge bottoming formation has been taking place since October 2007.
The upper boundary of this formation is between 4.75 percent — 4.85 percent. After a strong rise at the end of last week, yields are back at this technically important level. The short-term nature of this rise makes an immediate breakout above that resistance zone highly probable.
As you can see, yields shot up from late August 2010 — when Fed chairman Bernanke first announced his plans for QE2 — until mid-December. Then a consolidation phase began, which lasted seven weeks, until late last week when yields broke upwards. This reconfirmed the uptrend, and gave a short-term signal for rising rates.
A Secular Trend Change
In the Making
Before we discuss the fundamental picture of the Treasury bond market and some very important implications of rising rates, let’s have a look at the chart below going back to 1980. Here you can see the whole secular downtrend in yields — starting in 1981 with the 30-year Treasury at nearly 15 percent.
You may remember that Paul Volcker, who was appointed Fed chairman in August 1979, promised to fight inflation tooth and nail. His announcement was followed by strong monetary action to break inflation’s grip.
Well, the market didn’t believe him and ignored the major policy change he had implemented. Yields kept rising until October 1981, when they hit an important high. This was the turn of an era — the start of a secular downtrend that lasted nearly three decades.
In late 2008, during the height of the financial system and banking crisis, yields reached a major low at around 2.5 percent. This steep decline and the panic which accompanied it may actually turn out to have been the final low of the secular downtrend that began 27 years earlier.
But secular trends rarely turn on a dime. That’s why I foresaw a long, drawn out bottoming phase. And now it looks as if that’s exactly what has finally happened.
The chart above shows a huge bottoming formation lasting three years. And yields seem to be on their way to breaking above its upper boundary, shown by the red horizontal line, at approximately 4.8 percent.
A Mirror Image of 1979-1981
Similar to what we experienced in 1979-1981, the market has been reluctant to react on major fundamental signs of a secular trend change. The Fed started with quantitative easing in 2008. At the same time government debt started to go through the roof with no end in sight.
Ben Bernanke, an outspoken inflationist, has constantly praised the printing press making clear that he is willing to inflate no matter what. But many market participants weren’t convinced that he would succeed in bringing inflation back, and instead they expected deflation.
Well, I am an outspoken critique of Bernanke’s inflationary and bubble-blowing policy. But I do share his officially stated conviction that a dedicated central bank in a fiat money system can always create inflation. And to me, he seems very dedicated.
Interestingly, Bernanke seems to think that it is possible for a central bank to ignite inflation and — at the same time — hold interest rates low. According to Bernanke himself, QE2 was meant to manipulate interest rates lower. Well, that’s not the way it has worked out: Yields are much higher now than before QE2 was announced!
Maybe the market has finally awakened and realized that ultra easy monetary policy with negative real rates and ballooning budget deficits are a recipe for rising inflation. At least that’s what sound economic theory tells us and what the history of inflation convincingly confirms.
Rising Interest Rates
Have Dire Implications
|
The financial crisis that started in 2007 with the collapse of the subprime mortgage market is not over. It has been halted temporarily by implementing the largest fiscal and monetary stimulus in peace times. But the underlying problems have not been solved, not even properly addressed.
All we’ve seen is major bailouts, money printing and a government debt binge. That’s the “kick the can down the road policy,” which only aggravates the problems that will haunt us in the future. And rising rates may easily turn out to be the catalyst to begin the next phase of this crisis.
Our economies are highly indebted, not just the official sector, but also private households, consumers, corporations. The leveraged structure of our economy and especially of our financial system is extremely vulnerable to rising interest rates.
Moreover, there is a huge mountain of derivatives overhanging the banking sector, most of them related to interest rates in one form or the other. Rising interest rates will test the resilience of these structures. And I doubt that they will stand this test.
Plus there is …
The Negative Impact of Record
Money Flows into Bond Funds
Bond funds have seen major inflows during the past two years with rates at extreme lows and Bernanke assuring the world that he was going to print, and print, and print via QE.
And record money flows into bond funds are another strong argument for a major trend change in the making …
When private investors stampede into an asset class, a major high is just around the corner. We saw this in 1999-2000 with record money flows into stock mutual funds. And we saw it again in 2006-2007 when almost everybody was going bonkers over the housing market.
Simply put, as the masses go strongly into one direction you better get out and start looking the other way.
One thing is for sure: Bond holders are victims of higher inflation rates. And they will lose in a big way if Bernanke gets what he wants.
That’s why I recommend taking three steps before the bond market comes crashing down:
Step #1—
Review Your Bond Portfolio
If you own longer term bonds — not just Treasury bonds but longer-term bonds of any origin — or bond funds — you definitely should consider selling.
And if you want to profit from rising rates …
Step #2—
Consider an Inverse Bond ETF
Inverse exchange traded funds (ETFs) are meant to go the opposite direction of the index they track. One example is ProShares UltraShort Barclays 20+ Year Treasury ETF (TBT). This ETF seeks daily investment results that correspond to twice the inverse of the daily performance of the Barclays Capital 20+ Year U.S. Treasury Bond Index.
So for every 1 percent the index drops, you stand to make 2 percent.
You might also want to look at the suggestion my colleague, Mike Larson, offered last Friday using ProShares Short 20+ Year Treasury (TBF).
Step #3—
Become Informed
If you want to learn more critical background information about money printing, asset bubbles, opportunistic central bankers, and government debt and what this all means for your financial health, I suggest you get a copy of my new book, The Global Debt Trap. Click on your choice of bookseller to order it online — Amazon, Barnes & Noble or Books-A-Million — or stop by your nearest bookstore.
Best wishes,
Claus
{ 1 comment }
So what might the senario be that would cause those treasury short ETF’s to lose value? They look like a can’t miss investment at this point in time.