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Importance of Watching 10 Year U.S. Treasuries, Impacts on £1.5 Quadrillion of Derivatives

Stock-Markets / Financial Markets 2013 Aug 19, 2013 - 01:52 PM GMT

By: Money_Morning

Stock-Markets

Keith Fitz-Gerald writes: The esoteric - yet highly accurate - Hindenburg Omen we looked at Friday may suggest the probability of a market crash. But the number I'm watching this week could cause one.

As a standalone figure, of course, the yield on 10-year Treasuries is small. But the amount of money it impacts worldwide is flat-out staggering.


Out of the estimated $1.5 quadrillion dollars' worth of derivatives on the planet right now, roughly $500 trillion is specifically related to interest rates.

So you can see why the 10-year gets so much attention. But right now, I'm watching it even more carefully... for one important reason.

When the Hindenburg was sounding the alarm last week, 10-year Treasury yields spiked at the same time, up to 2.8210% before relaxing a bit in early trading last Friday as of press time. That suggests to me the Fed is losing control over interest rates.

No doubt this is a frightening scenario, which is why it's important to remember...

There's plenty you can do about this now.

First, here's why higher rates could have such a wide impact...

The 5 Side Effects of "No Control"

Many investors believe the Fed controls interest rates. That's not true - they merely influence them.

As I have long written here in Money Morning, it's the traders who have a death grip on our financial markets.

And if interest rates rise much further, the support the Fed is counting on in the bond markets may not be there. In fact, it may be running the opposite direction.

And here's why that could trigger a selloff:

  1. Foreign custody holdings of U.S. Treasuries continue to decline, which implies that our trading partners don't trust our repayment ability. So they're moving on to other assets.

  2. Money managers are seeing extremely high levels of redemption requests and withdrawals from bonds. PIMCO, for example, experienced a $7.5 billion hit last month as money headed for the exits. The presumption is that the money is rotating into stocks, but the data suggests a solid portion is simply going back under the mattress. Somebody has to make up the gap; the only one big enough is the Fed. But if $85 billion a month isn't good enough, you've got to wonder how much is. Bernanke's replacement will have his or her hands full and the stakes couldn't be higher.

  3. Loan volumes have fallen sharply as America continues to deleverage. International data suggests the same is true, generally speaking, throughout Europe and in Asia as well. So banks don't need to buy Treasuries as a means of supporting profits and corresponding balance sheet liabilities. Combine that with huge real estate mark-to-market losses that have yet to be taken, and there's a hole the size of Bernanke's printing press to dam... or damn, depending on your perspective.

  4. Institutional managers - read pension fund administrators, foreign banks, and ETFs - who would have normally been big buyers, are paring back because they don't want the exposure that comes with 10-year paper or longer-term assets in a rising rate environment.

  5. The risk the Fed thinks it's insuring here in the United States is really global. Team Bernanke and his minions have already socialized risk, so there is literally nowhere to run in the halls of big government.

Yikes!

So now what?

For one thing, people are going to come to understand what we at Money Morning have known all along: Money printing is not the solution. It's THE problem.

I don't care what Bernanke and his central banking boffins say, you cannot print money forever, nor can you expect people to tolerate doing so into perpetuity. Eventually you have to pay back what you owe... or default.

Bailouts never solve the problem. At the end of the day, they merely push them off.

As I see it, there are two possible outcomes: a) a catastrophic default or b) a controlled default. And I'm not alone in my thinking.

Legendary investor Jim Rogers has been very clear from the beginning that this will end badly. Mark Mobius believes default has to happen, especially in Europe, where he's noted that governments will "stretch out payments so that at the end of the day, as economies recover, they are gradually able to pay off these debts."

So how do you protect your portfolio?

Four Ways to Sleep at Night

  • The most obvious thing to do is take profits ahead of time as a safeguard to the current turbulence becoming something worse. If you're up big, consider converting gains of 100% or more into "free trades" like Money Map Report subscribers have done throughout this financial crisis. That way, you bank the gains and are effectively playing with house money, having paid for your initial investment.
  • That's followed closely by purchasing insurance. I'm a big fan of inverse ETFs and put options because they allow investors to spend a comparatively small amount of money while potentially protecting broad swathes of their portfolio. Futures, because of their leverage, can be even more effective, but they are clearly not for everybody.
  • While you're at it, don't leave out trailing stops. These are simple protective orders that ensure you sell specific holdings at some dollar or percentage level below where an investment is trading now. Doing so removes emotion from the equation in the heat of battle while making certain that you capture profits and protect against small losses before they become catastrophic ones.
  • And finally, go shopping. You heard me... Get ready to buy, especially when you can get something the world needs at a discount. Energy, certain kinds of tech and inverse b

The markets show beyond any shadow of a doubt that the vast majority of investors do exactly the right thing at precisely the wrong time. That's why they're always buying when they should be selling and selling when they should be buying. Barron's research suggests that 85% of all buy/sell decisions are incorrect.

If you know that, and everybody heads for the exits at once, this is about as close to a glaring green light as you're going to get.

Admittedly, I know each of these things is hard to do. It takes nerves of steel to wade in when "everybody" knows that the worst is about to happen, or is happening. It also takes unparalleled confidence to step into the middle of something like the financial markets when everybody else is fleeing.

Yet, that's exactly what the savviest investors in the world will do.

I want you to be among them.

Source :http://moneymorning.com/2013/08/19/the-most-important-number-to-watch-this-week/

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Disclaimer: Nothing published by Money Morning should be considered personalized investment advice. Although our employees may answer your general customer service questions, they are not licensed under securities laws to address your particular investment situation. No communication by our employees to you should be deemed as personalized investent advice. We expressly forbid our writers from having a financial interest in any security recommended to our readers. All of our employees and agents must wait 24 hours after on-line publication, or after the mailing of printed-only publication prior to following an initial recommendation. Any investments recommended by Money Morning should be made only after consulting with your investment advisor and only after reviewing the prospectus or financial statements of the company.

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