Posts tagged ‘rates’

So do you want rates to rise or don’t you?

Written June 4th, 2013

I’m confused. If zero rates are so bad, why will it be bad if rates rise? Asked another way: If you paint yourself into a corner, how do you get out without stepping on the floor? Answer: Simple – you don’t. Zero rate ARE bad and it WILL hurt when they rise, but it doesn’t mean they shouldn’t.

Bill Gross came out with a piece today, and summarized the current conundrum thus:

In the process of reaching and stooping, prices on financial assets have soared and central banks have temporarily averted a debt deflation reminiscent of the Great Depression. Their near-zero-based interest rates and QEs that have lowered carry and risk premiums have stabilized real economies, but not returned them to old normal growth rates. History will likely record that these policies were necessary oxygen generators. But the misunderstood after effects of this chemotherapy may also one day find their way into economic annals or even accepted economic theory. Central banks – including today’s superquant, Kuroda, leading the Bank of Japan – seem to believe that higher and higher asset prices produced necessarily by more and more QE check writing will inevitably stimulate real economic growth via the spillover wealth effect into consumption and real investment. That theory requires challenge if only because it doesn’t seem to be working very well.

He goes on to succinctly summarize the implication:

Why it might not be working is fairly clear at least to your author. Once yields, risk spreads, volatility or liquidity premiums get so low, there is less and less incentive to take risk.

Sure, investors might switch from one overpriced asset to another, but zero bound rates mean companies are hesitant to invest in R&D, savers are hesitant to redeploy now, and entrepreneurs are hesitant to take additional risk on by hiring with lines of credit. I see risk-off everywhere – the business owner not wanting to rent a bigger space to the banker pulling in lines of credit. It’s even bigger than Bill Gross mentions, partly because companies don’t have any control of pricing, consumers aren’t seeing income growth, and on and on and on.

In that light, if the Fed leaves rates low, risk will continue to be mispriced, employment will continue to stagnate, and eventually margin compression will occur and equities will go down. On the other hand, if the Fed increases rates, any financial asset prices dependent on leverage will be forced to come down. So the Fed is in a bind. It can’t leave rates here, because it’s not stimulative, but it can’t raise rates either. It can try to lower them ala Japan, but that didn’t prove to work either. So, it’s just a matter of determining what is the path of least pain. I don’t think anyone has the answer to that one, although many think they know.

Relevant ETFs: TBT, TLT, UUP, GLD

Why not short treasuries?

Written June 3rd, 2013

I know you’re tempted to short treasuries. From 1.70 to 2.17 on the 10-year in no time at all. Who knows how much further it can go. Maybe we’ll even see 4% rates in our lifetime again. But don’t, and here’s why.

It seems so reasonable that rates would finally rise. Even the Fed is talking about tapering their purchases.



And yes, rates have gone up significantly on a percentage basis (although, they are back to where they were in early 2012), so who’s to say they won’t continue rising now…

I don’t buy it. Rates aren’t going up anytime soon, and here are just a few reasons why:

  • The Fed isn’t tapering, it’s just testing the waters. The answer it got was the one it expected: don’t stop. The back up in rates has given the Fed more room to start anew and more political pressure to keep going. After all, what president or senator wants to tell his/her constituents that their mortgage rates are going to go up and house price gains will stagnate.
  • Money has only begun to flow into the dollar. And once in the dollar, it’s gotta go somewhere.


  • On a relative basis, where will money prefer to be? What pension fund is going to increase its allocation to European debt or Japanese debt? Even Japan’s own pension system is trying to dump JGBs and go into equities. 
  • Retirees still prefer 2% yield and no vol to 3-4% dividends with lots of vol. And even those 3-4% yields aren’t looking that great these days as the days of “fat” dividends seem long gone.
  • The bond bull isn’t going to end when people sell positions slowly in reaction to some “tapering” comments. The bond bull will end AFTER everyone buys into the theory that government debt issuance isn’t a problem.

We are close to the end. But I don’t think we’re there yet, and treasury shorts might be able to play some short term moves, but overall, they’ll get squeezed, and shorting treasuries will become the new widow-maker trade.

Relevant ETFs: TLT, TBT, UUP



Bonds Yields and Stocks

Written March 22nd, 2012

Why is everyone so convinced the low bond yields will push investors into stocks? Earlier today, I read about an interview with Mobius, the famous emerging markets portfolio manager at Templeton, where he highlighted:

“People are now beginning to realize that they cannot be sitting on bonds that are paying one, two or even three percent, when inflation is running higher than that,” Mobius said, adding that investors would look increasingly at equities as an alternative.

“If you look at equities of course, the yields are much, much greater than the bonds.”

The sentiment has lately been a favorite of pundits on CNBC and everywhere else. The argument is that given low bond yields, the yield on equities is looking attractive. Additionally, given that inflation is going to rise, stocks are a better investment than fixed income. Two separate reasons, both of which are flawed.

Let’s take the argument that equity yields are higher than bond yields. So investors are currently demanding a higher yield from the more volatile asset than the less volatile asset? Did you know that this used to be the default scenario? Equity investing used to be viewed as risky, and bonds were the refuge of the conservative investor. Most investors until 1950 were quite comfortable with a higher yield in stocks, specifically because they were riskier. This relationship flipped with changes in the tax code, the advent of EMH, the invention of the 401K, discount brokerage, etc. Most investors, though, grew up with bond yields higher than equity yields and can’t imagine the opposite. Now, I’m not saying don’t buy stocks . . . I’m just saying that if you’re going to buy stocks, the yield pickup will come with a volatility pickup that you need to accept, and in that light the yield, by itself is not a reason to invest today.

The second argument, that stocks are a good inflation hedge, rests on two assumptions. The first is that we’ll experience (or are already experiencing) inflation. Choose your metric and statistic, but in the end, every individual will make up their own mind on whom to believe. The second assumption seems more flawed – that stocks will provide a hedge. Here’s where magnitude will matter. Stocks may provide a hedge against low to moderate inflation, since they can theoretically increase sales to keep up with inflation, however, in periods of high inflation that has not been the case. More importantly, we are coming off historically high margins. If an investor does indeed expect inflation to hit, then traditionally, margin compression should occur anyway, but certainly from this high starting off point. An investor would need to believe that stocks would rise despite the margin compression, and would benefit from a significant P/E expansion – a highly unlikely scenario in a time of price instability (high inflation or deflation). (For further reference, check out our previous discussions on the Y-curve.)

Where does this leave us? It leaves us at a much more negative point than most analysts would conclude. Their conclusion is that investors should seek safety in stocks, as an alternative to bonds. My conclusion is that both are risky at these levels and investors should tread carefully. The biggest bond bull market in history coincided with the biggest equity rally in history (ca 1982-2000), and while bonds continued their run, both assets moved in tandem for a long time. The odds in my book is that they’ll move together again sooner than we want, and it will be in the opposite direction. The reasons to buy equities should come from low valuations relative to assets and earning power – not where we are now. Low bond yields, by themselves, are perhaps reasons to avoid treasuries, but not necessarily good enough reasons to buy stocks.

Relevant ETFs: SPY, IWM, TLT, TBT, SH

Revisiting the 10 year

Written July 28th, 2011

One might think that a looming debt downgrade would cause a sell-off in treasuries…One would be wrong. The 10 year is not at the highest level ever, but let’s put rates in perspective. Here’s a chart of the past 2 decades:

Rates are not at the lowest points reached in 2009, but they’re still pretty low by historical standards. Conforming 30 year mortgages are still below 5%. 15 year mortgages are below 4%! Now, if that can’t boost the real estate market, then obviously rates aren’t the determining factor in people’s purchasing decisions at this point. As a side note, refinancing for those who haven’t done it already, can still be an attractive option if you’re looking to either lower your payments and/or take out equity.

Back to the 10 year, I must admit that its resilience is impressive. Does it point to a coming hyperinflationary period? No, and in fact, it’s pointing to exactly the opposite. THAT must be keeping Bernanke up at night. He can’t print enough to stimulate the inflation he wanted. THAT must keep Obama up at night since the only people benefiting are a few mid-western farmers who have seen their crop and land prices rise. The problem for him is that those are a slim minority and certainly not his base, who are along the coasts and seeing their food inflated without the wage increases.

The strength in the 10 year is a signal of fear not stability, and the coincidence with the continued strength in gold lends support to my bi-flationary environment where world growth slows down dramatically, and sources of wealth from wages, equities, and real estate are pressures, while expenses get pressures upward through devalued currencies, geopolitical unrest, etc. Capital preservation and flexibility are the keys to our investing thesis in this environment.


Appearance on The Wall Street Shuffle

Written October 14th, 2010

Here’s a link to my radio appearance yesterday on The Wall Street Shuffle.

The basic gist revolved around the weakening dollar causing some wide divergences that are disconcerting but that also provide opportunities.

China putting more reserves in gold?

Written October 13th, 2010

Gold is rallying on rumors that China is planning on putting more reserves into gold.

The CRB in general is being pulled up by gold, while the counter-trader is to sell treasuries as investors worry that China won’t step up to the plate in the same way as it used to.

Fed – deflation fears dominate

Written September 21st, 2010

First, click here if you want to see the statement in its entirety.

Second, note that Hoenig was a lone dissenter.

Third, the Fed is confirming slow growth and fearing deflationary pressures and stands ready to inject further liquidity.

Fourth, predictions of an imminent announcement of QEII were premature, although Fed bond purchases continue without such announcement and rates are incredibly low. Could they go lower? For sure, but again, I don’t think 10 year rates will fall below 2 (I don’t even think they’ll get to 2 – but it’s an easy round number to point to).

Euro is going to 1.32 as we speak.

Yen is stronger as well at 85.2.

Gold went from down to up in 10 minutes.

And the market is up over 50 points as I write this.

More to come…

Repo rates on the rise

Written March 23rd, 2010

March and April may end up being pivotal months for our rate discussions. On the one hand, we have MBS purchases slated to be finished by the end of March. On the other you have the implementations of the Supplementary Financing Program.

Check out the LIBOR 3 Month chart:

libor3 (Source:

It will be interested to see if this continues, stabilizes here, etc. and how it flows through to the rest of the curve and pricing structure.

For a quick summary of the situation, click here.

It’s always easier to give advice…

Written February 10th, 2010

We were great at giving advice to Japan throughout their lost 2 going on 3 decades, and we’re great at giving advice to Europe on whether and how to deal with Greece. Yet, we’re incredibly bad at following our own advice, from propping up zombie banks to dealing with states with unfunded liabilities.

We have written often about the coming crisis in the municipal debt markets, and it seems like others are recognizing the problems as well. Barry Ritholz recently posted the following:

Insolvent European vs. American States

While all the investing world seems to be utterly fixated on the outcome of Greece’s solvency woes, perhaps we need to step back and put this into perspective.

Portugal, Ireland, Italy Greece and Spain are in varied degrees of difficulty; but how significant are the PIIGS’ debts to the world’s economy? (If they require a workout, perhaps they can what we do. Give them lower rates and an extended term and/or a cramdown to their lenders).

In contrast, consider the distressed United States: How do our own economic “pigs” measure up? In terms of economic importance relative to the world, aren’t the bigger US States that are in deep distress more important (GDP sizewise)?

Consider the size of the budget issues and debt load in dollar and percentage terms for just these six states relative to their European cousins:

You Can’t Put Lipstick on These PIGS:

Budget gap (as a % of the total budget): 22%
Gap: $22.2 billion

New York
Budget gap (as a % of the total budget): 9.8%
Gap: $5.5 billion

Budget gap (as a % of the total budget): 19.9%
Gap: $5.1 billion

New Jersey
Budget gap (as a % of the total budget): 7.7%
Gap: $2.5 billion

Budget gap (as a % of the total budget): 19.9%
Gap: $2 billion

Budget gap (as a % of the total budget): 16%
Gap: $1.2 billion

All data for fiscal year 2008
Source Businessweek

All by itself, the insolvent nation-state of California is the 8th largest economy in the world. Its the size of France. According to the CIA Factbook, Greece is number 34. That is a lot of hyperventilating about a relatively small impact to global GDP. Italy is 11, Spain is 13, Portugal is 50, and Ireland is 56.

Additionally, in the US, we have 43 of the 50 states in some form of financial distress.

Perhaps the solution to California’s woes is for Arnold (who is from Austria) to have California join the EU. Then, they might qualify for a bailout from Germany . . .

And others have begun to point out the same issues. Ritholz doesn’t even mention the $2 trillion in unfunded pension liabilities, the increase in Medicaid costs that are far outpacing inflation and growth, and the mistaken estimates for receipts that are consistently coming in short.

The main difference, of course, is that there isn’t any doubt about whether the Federal government will bail out California, or Arizona, or New York. In return for the bailout, states will continue to lose the little power they have left. On the other hand, the federal government will gain an unimaginable increase in liabilities that are not currently accounted for by the market. The result continues to point to higher rates.