Best of the Week
Most Popular
1. Investing in a Bubble Mania Stock Market Trending Towards Financial Crisis 2.0 CRASH! - 9th Sep 21
2.Tech Stocks Bubble Valuations 2000 vs 2021 - 25th Sep 21
3.Stock Market FOMO Going into Crash Season - 8th Oct 21
4.Stock Market FOMO Hits September Brick Wall - Evergrande China's Lehman's Moment - 22nd Sep 21
5.Crypto Bubble BURSTS! BTC, ETH, XRP CRASH! NiceHash Seizes Funds on Account Halting ALL Withdrawals! - 19th May 21
6.How to Protect Your Self From a Stock Market CRASH / Bear Market? - 14th Oct 21
7.AI Stocks Portfolio Buying and Selling Levels Going Into Market Correction - 11th Oct 21
8.Why Silver Price Could Crash by 20%! - 5th Oct 21
9.Powell: Inflation Might Not Be Transitory, After All - 3rd Oct 21
10.Global Stock Markets Topped 60 Days Before the US Stocks Peaked - 23rd Sep 21
Last 7 days
Stock Maket Trading Lesson - How to REALLY Trade Markets - 26th Nov 21
SILVER Price Trend Analysis - 26th Nov 21
Federal Reserve Asks Americans to Eat Soy “Meat” for Thanksgiving - 26th Nov 21
Is the S&P 500 Topping or Just Consolidating? - 26th Nov 21
Is a Bigger Drop in Gold Price Just Around the Corner? - 26th Nov 21
Financial Stocks ETF Sector XLF Pullback Sets Up A New $43.60 Upside Target - 26th Nov 21
A Couple of Things to Think About Before Buying Shares - 25th Nov 21
UK Best Fixed Rate Tariff Deal is to NOT FIX Gas and Electric Energy Tariffs During Winter 2021-22 - 25th Nov 21
Stock Market Begins it's Year End Seasonal Santa Rally - 24th Nov 21
How Silver Can Conquer $50+ in 2022 - 24th Nov 21
Stock Market Betting on Hawkish Fed - 24th Nov 21
Stock Market Elliott Wave Trend Forecast - 24th Nov 21
Your once-a-year All-Access Financial Markets Analysis Pass - 24th Nov 21
Did Zillow’s $300 million flop prove me wrong? - 24th Nov 21
Now Malaysian Drivers Renew Their Kurnia Car Insurance Online With Fincrew.my - 24th Nov 21
Gold / Silver Ratio - 23rd Nov 21
Stock Market Sentiment Speaks: Can We Get To 5500SPX In 2022? But 4440SPX Comes First - 23rd Nov 21
A Month-to-month breakdown of how Much Money Individuals are Spending on Stocks - 23rd Nov 21
S&P 500: Rallying Tech Stocks vs. Plummeting Oil Stocks - 23rd Nov 21
Like the Latest Bond Flick, the US Dollar Has No Time to Die - 23rd Nov 21
Why BITCOIN NEW ALL TIME HIGH Changes EVERYTHING! - 22nd Nov 21
Cannabis ETF MJ Basing & Volatility Patterns - 22nd Nov 21
The Most Important Lesson Learned from this COVID Pandemic - 22nd Nov 21
Dow Stock Market Trend Analysis - 22nd Nov 21
UK Covid-19 Booster Jabs Moderna, Pfizer Are They Worth the Risk of Side effects, Illness? - 22nd Nov 21
US Dollar vs Yields vs Stock Market Trends - 20th Nov 21
Inflation Risk: Milton Friedman Would Buy Gold Right Now - 20th Nov 21
How to Determine if It’s Time for You to Outsource Your Packaging Requirements to a Contract Packer - 20th Nov 21
2 easy ways to play Facebook’s Metaverse Spending Spree - 20th Nov 21
Stock Market Margin Debt WARNING! - 19th Nov 21
Gold Mid-Tier Stocks Q3’21 Fundamentals - 19th Nov 21
Protect Your Wealth From PERMANENT Transitory Inflation - 19th Nov 21
Investors Expect High Inflation. Golden Inquisition Ahead? - 19th Nov 21
Will the Senate Confirm a Marxist to Oversee the U.S. Currency System? - 19th Nov 21
When Even Stock Market Bears Act Bullishly (What It May Mean) - 19th Nov 21
Chinese People do NOT Eat Dogs Newspeak - 18th Nov 21
CHINOBLE! Evergrande Reality Exposes China Fiction! - 18th Nov 21
Kondratieff Full-Season Stock Market Sector Rotation - 18th Nov 21
What Stock Market Trends Will Drive Through To 2022? - 18th Nov 21
How to Jump Start Your Motherboard Without a Power Button With Just a Screwdriver - 18th Nov 21
Bitcoin & Ethereum 2021 Trend - 18th Nov 21
FREE TRADE How to Get 2 FREE SHARES Fractional Investing Platform and ISA Specs - 18th Nov 21
Inflation Ain’t Transitory – But the Fed’s Credibility Is - 18th Nov 21
The real reason Facebook just went “all in” on the metaverse - 18th Nov 21
Biden Signs a Bill to Revive Infrastructure… and Gold! - 18th Nov 21
Silver vs US Dollar - 17th Nov 21
Silver Supply and Demand Balance - 17th Nov 21
Sentiment Speaks: This Stock Market Makes Absolutely No Sense - 17th Nov 21
Biden Spending to Build Back Stagflation - 17th Nov 21
Meshing Cryptocurrency Wealth Generation With Global Fiat Money Demise - 17th Nov 21
Dow Stock Market Trend Forecast Into Mid 2022 - 16th Nov 21
Stock Market Minor Cycle Correcting - 16th Nov 21
The INFLATION MEGA-TREND - Ripples of Deflation on an Ocean of Inflation! - 16th Nov 21

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

How to Profit from Rising Interest Rates

Interest-Rates / US Interest Rates Feb 11, 2011 - 05:16 PM GMT

By: Terry_Coxon

Interest-Rates

Best Financial Markets Analysis ArticleTerry Coxon, The Casey Report writes: In the fall of 2008, the Federal Reserve responded to the Lehman bankruptcy by igniting a rapid expansion in the U.S. money supply. It did so because, by its lights, the immediate and obvious menace to the economy was a deflationary collapse, with one giant bankruptcy breeding another. And it went about the task without compromise; the monetary base more than doubled in less than a year, and the public's M1 money supply (checkable deposits plus hand-to-hand currency) jumped by 20%.


To some investors, including many of the editors at Casey Research, this policy seemed to guarantee price inflation sooner or later – which, when it came, would mean higher interest rates and falling prices for long-term bonds, including Treasuries. Or, as a speculator would put it, when the time comes, a lot of money can made by shorting T-bonds.

But "sooner or later" is a nearly useless foresight. So far, as Treasury bonds were concerned, the fear brought on by the bursting of the housing bubble, tumbling stock prices, the near-death experiences of large financial institutions, and the well-publicized bailouts of public companies trumped any concerns about inflation somewhere in the future. The compelling desire, especially among institutional investors, was to escape default risk, and that meant buying Treasuries. Inflation was a hypothetical event that could be dealt with later.

For investors who've followed the inflation-vs.-deflation debate and who've come down on the side of inflation, shorting Treasuries looks like a sure thing – and has looked that way for the last two and one-quarter years. But for investors who acted sooner rather than later, results have been disappointing. Every time rates started to rise, bad news from somewhere would revive fears of everlasting recession, a new wave of defaults, or a tumble into the deflationary abyss. Housing prices would take another step down. The reported unemployment rate would stall or rise. The specter of a default in the sovereign debt of a European country would reappear. And every time, whatever the problem, it would stimulate flight-to-safety demand for U.S. Treasury securities. So there was no sustained rise in T-bond yields.

Shorting an investment has costs. In the case of a bond, even if the price stands still, the cost of maintaining a simple short position is the difference between the yield on the bond (which the short-seller must pay) and the yield on the cash that is credited to the short-seller's account. You can't dodge that cost by using futures, options, or an exchange-traded fund. Regardless of how the instrument is put together, the performance will reflect the cost of a simple short sale. So while the investor who bet on rising T-bond rates as soon as the Fed turned on the printing press didn't get whacked by the behavior of bond prices, he did suffer a substantial, ongoing leakage.

Stacking the Deck

If you were one of the earlier investors, you may have already thrown in the towel. With the meter running, being early doesn't feel much better than being wrong. But I believe that the mere passage of time plus the accumulation of inflationary forces (also known as "stimulus") has stacked the deck in favor of shorting Treasury bonds as a timely move. Later is now. Here are the reasons.

  1. The government has actually done what it said it would do. It has run trillion-dollar-plus annual deficits, and it has bloated the M1 money supply. (That's the accumulation of inflationary forces.)

  2. With QE2 (the second round of money creation and attempted interest-rate suppression), the Federal Reserve will be doing more of the same at least into the middle of 2011. And with the current federal budget plans, the Treasury also will be continuing on the path it set upon late in 2008.

  3. Inflation is starting to look overdue, which increases the chance that it's not too far away. The effects of money creation don't follow a tight schedule – moving more like a jitney than a metronome. But on average, a burst of money creation will have its peak effect on economic activity 9 to 18 months later, and the peak effect on price inflation may not show up until a year after that. It's now two and one-quarter years since the monetary burst began.

  4. The stock market has been doing what it usually does before economic activity starts picking up – it's been rising.

Does this add up to a sure thing of rising yields and falling prices for Treasuries in 2011? No. But it does stack the deck, which is all a speculator can ask for.

How It Might Look

If a rise in T-bond rates is what lies in the near future, there are three ways it might play out.

The first is a gradual but persistent rise. As the economy recovers, so does the demand for loans, so interest rates on all types of credit instruments, including T-bonds, also rise. And as the fears of 2008 and 2009 become more distant, the public leans more and more toward spending the excess cash the Federal Reserve has created, so inflation picks up. And keeps picking up. So interest rates keep rising.

The second possible pattern is a sudden jump in interest rates as investors seek to dump dollar-denominated bonds. The triggering event might be a new war that guarantees even bigger federal deficits or an announcement from the Federal Reserve that it is considering QE3. As we've seen with the serial sovereign debt crises in Europe, a flutter from any not-so-white swan can set things off.

And, of course, the rise in interest rates could begin with the first pattern and then jump into the second.

How It Might Be Interrupted

The dollar is still the world's currency, the U.S. Treasury still looks like the world's most reliable sovereign borrower, and by the standards of most of the world, the U.S. still looks like a haven of stability. So any troubles outside the U.S. that didn't directly threaten the U.S. would bring flight-to-safety buying, which would temporarily depress T-bond rates. Or an actual default by Greece or any of the other popular candidates for sovereign bankruptcy would, for a while, reverse the rise in Treasury bond yields. A major war that the U.S. stayed out of (if you can imagine such a thing) would have the same effect.

Any such setback for short-sellers of Treasury bonds would be short-lived. The reason for expecting a rise in rates isn't the events that lie ahead. It is the money creation and the deficits that have already occurred.

How to Place Your Bet

The most efficient and reliable way to speculate on rising interest rates is something most investors don't want to do – use the futures market. If you do take that route, I suggest shorting the 10-year T-bond. That's the maturity the Federal Reserve is targeting with QE2. There is no better way to boost your odds than to short the bond whose price the government is trying to support. The fire-and-forget strategy would be to deposit sufficient margin (as required by the particular broker you trade through) to keep your position open even if the rate on the 10-year bond falls back to 2.4% – which is the low since 2007. That's the simple and cautious approach. It would limit your leverage, but it also might improve your sleep patterns.

The more convenient way to speculate on rising interest rates is to use the Rising Rates Opportunity 10 ProFund, which is a mutual fund that tries to emulate a non-leveraged short position in Treasury bonds. Such funds have an unavoidable shortcoming: maintaining a 100% short position in anything isn't easy when capital is flowing into or out of the fund every day. This may make an investment in fund shares more profitable or less profitable than a short position in the futures market that you establish for yourself. It adds another element of uncertainty, like play in a steering system. That's a flaw, but for an unleveraged fund, I wouldn't rate it as a disqualifying flaw since, as I want to make unmistakable, we're talking about a speculation.

[Terry Coxon is a contributing editor to The Casey Report, Casey Research’s flagship advisory for big-picture investing. For a very limited time, you can now get one full year of The Casey Report for only $98 – that’s 72% off the regular price. Sign up risk-free, with our 3-month money-back guarantee. But hurry, this offer ends soon… details here.]

© 2011 Copyright Casey Research - All Rights Reserved

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in