With all the talk> of needing to further regulate speculators, hedge funds and other financiers, it's somewhat ironic that the biggest player in the financial markets is the Federal Reserve. It is not a federal agency or subject to a full independent audit, despite operating with a highly leveraged and inexhaustible pile of assets backed by the country itself.
Last week, we covered the Fed's most recent speculation, an additional $600 billion worth of "quantitative easing" designed to stimulate the economy and keep interest rates low.
I always stress the importance of focusing on a security's price action because, well, that's what we trade. The truth is that it's not the news, but the market's reaction to the news, that matters most.
Are Rates Really Starting to Rise?
Bearish price action is bearish. Bearish price action in the face of supposedly bullish news is even more so. After the Fed announced plans to buy bonds, prices for those bonds fell>, sending the interest rate on the 10-year-note up by the most since last December and to the highest yield in two and a half months. The 30-year bond also dropped, now yielding 4.30%, up from 3.53% just three months ago. Bond yields move inversely to prices.
The public attention surrounding the announcement, with everyone from YouTube satirists to Sarah Palin offering their analysis, reminded me of a not-so-dissimilar maneuver back in 1999, when the United Kingdom famously, and in a similar public fashion, announced plans to sell half the country s gold reserves.
At the time, gold was trading at $283 an ounce, a nearly 20-year low. Gold began a record run to all-time-highs not long after the U.K. finished selling in 2002. Having dumped 415 tons at an average price of $276 an ounce (now $1,370), it's estimated that the British Government lost $10 billion on the sale. In Europe, the $252 low for gold has been nicknamed the Brown Bottom, after Gordon Brown, then the U.K. Chancellor of the Exchequer who authorized the sale.
Big public governmental announcements can often mark the end of a move rather than the beginning of one. And as the Fed works even harder to push interest rates down, now might be the time to consider an exposure to benefit if they rise instead.
Among those worth a look are the new exchange-traded notes launched earlier this summer from iPath. ETNs track various strategies and asset classes, but unlike exchange-traded-funds, they are an unsecured obligation of the issuer, in this case Barclay's, and don't actually hold the asset in question.
The Dow Jones-AIG Tin Total Return Sub-Index, for example, has more than doubled since we wrote about it last year.
Betting Against Bonds
Within fixed-income, iPath offers three notes that will directly benefit if rates continue to climb: iPath U.S. Treasury 2-year Bear ETN, iPath US Treasury 10-year Bear ETN and iPath US Treasury Long Bond Bear ETN. The jump in longer-term interest rates has already boosted DLBS by nearly 10% since early October.
Given the public's recent appetite for bond funds, $375 billion having been invested in 2009 and over $220 billion in 2010, not to mention dividend paying stocks, it's clear many investors are now taking seriously the Fed's promise to maintain low interests rates for "an extended period".
Consider these as useful tools just in case the market itself has other ideas.