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It will impact every investment, every investor and virtually every financial decision you might make. It will affect you whether you’re rich or poor, debtor or creditor, conservative or aggressive. No matter what you do, you will have to understand it fully and watch it carefully. I’m talking about … Surging Interest Rates
Rates were rising gradually. Now, they’re rising more quickly. Plus, only short-term rates were going up. Now, ALL rates are starting to move higher. The yield on 30-year Treasury bonds, for example, was less than 4.20% in July. Now it’s close to 4.80% and marching steadily higher. This Treasury-bond yield, in turn, has an almost immediate and direct impact on mortgages, housing, autos and the entire economy. That’s why the 30-year fixed mortgage rate has jumped to 6.15% in the latest week, a 14-month high.
That’s a key reason General Motors and Ford are sinking so quickly. And that’s also why borrowing costs are going up for everyone — for corporations, local governments, consumers, and anyone who needs to borrow money. If you borrow money, that includes you. You’re going to have to pay higher rates on mortgages, auto loans, personal loans, credit card advances and business loans. Your broker is going to charge more for margin. The IRS will charge more for late tax payments. Higher rates will be built into nearly every investment and every financial transaction. I’ve Been Studying These Markets for 40 Years Back in 1965, when I was 19, I started helping my father and my uncle chart the rates on 3-month Treasury bills and 30-year Treasury bonds. That was our specialty.
My job was to take the numbers from their worksheets and plot them on oversized chart paper. And I remember the numbers vividly: Both short- and long-term rates were significantly higher than today’s. And yet, the danger of inflation was far lower than it is now.
Although those rates were far higher than today’s, the signs of inflation were far weaker. Today, Dad is also gone. But I can tell you flatly: Never before in my lifetime — and probably his as well — have we seen anything like the combination of circumstances we have right now: • We are just beginning to come off the lowest rates in a half-century, and … at the same time … • We can see some of the most virulent signs of inflation in a quarter-century. This is an Extremely People who make loans won’t accept this for a moment longer. They’re not going to tolerate one of the worst returns in their lifetime precisely when the value of their money could be falling at one the fastest rates in decades. Either these lenders are going to get a higher rate or they’re going to DEMAND a higher rate. And since they’re the ones holding the purse strings, they have all the power they need to make those demands. Remember: It’s the ones providing the financing — not the ones begging for it — that have the final say. And as you well know, among all the money beggars in the world today, the U.S. government is, by far, among the most cash-starved. That’s not exactly an enviable position to be in. Nor does it give America’s central bank — the Federal Reserve — much leeway in deciding what to do with interest rates. Some people, including some Fed officials themselves, may think rates move up and down based on their say-so. But history has proven this theory wrong so many times it’s not funny. Every time the Fed tried to deny the realities of inflation … and every time they tried to hold rates down despite those realities … they got kicked in their you-know-whats. I saw this happen in the 1960s, the 1970s and the 1980s. And I can see clearly how it’s going to happen again now. Indeed … There Are Several Reasons Why First, as I just told you, the discrepancy between (a) the high danger of future inflation and (b) the low level of interest rates is probably far greater today than at any time in modern history. That’s not something the Fed can fix by standing still or just raising rates gradually. Second, it’s not merely inflation that prompts lenders to charge you more interest. They charge you more interest if your credit rating goes down. They charge more if there’s a bigger crowd of people suddenly asking for loans. And they’ll charge still more if they themselves are running low on available cash to loan out. That’s precisely the kind of crunch we may be running into in the months ahead. Right now, for example, there are more people and institutions holding bigger debts than at any time in history. This means they need to continually borrow more money to pay off the debts coming due every day. Just in interest-bearing debt, and just among U.S. borrowers, the total debt pyramid is now more than $38.1 trillion.
And yes, the U.S. Treasury now owes a whopping $4.5 trillion to Americans and foreigners who hold U.S. Treasury securities. But the Treasury is not the biggest debtor. Not by a long shot! The biggest — and possibly shakiest — debtors right now are the millions of Americans who have taken out first and second mortgages on their homes. Indeed, the total pile-up of mortgage debt is now $11.1 trillion, or 2.5 times more than all U.S. Treasury debts. Where do I get this data? From the Federal Reserve’s second-quarter Flow of Funds report, table L4.
Treasury securities: $4,493.1 billion. Mortgages: $11,109.1 billion. This is huge. It’s everywhere. And it’s going to have a major impact on your financial life. At the outset, I showed you how the yield on 30-year Treasury bonds is going up. And I showed you how that’s driving up the rate on 30-year mortgages. Now, with these figures, I’m showing you how absolutely important these rates are — simply because the amount of money involved is so big. The enormous amount of mortgage debt is especially dangerous today because so much of it is based on • adjustable rates, So when rates go up, it sets off a chain reaction of events that’s beyond anyone’s power to control, certainly beyond the Fed’s.
Why are they so desperate? Because rates are going up. And with the new, stricter personal bankruptcy laws now blocking their way, Americans up to their eyeballs in mortgage debt are now more likely to borrow more from Peter to pay Paul. Instead of rushing to the bankruptcy court, they’re going to be rushing to their bank. That means more demand for credit card advances, more demand for emergency loans, and more demand for pawn-shop-type financing to tide them over until the next mortgage payment. In short, that means a bigger crowd of low-rated borrowers rushing to borrow at the same time. Also driving rates higher will be those American and foreign investors holding the trillions in U.S. Treasury notes and bonds. These investors don’t have to beg and grovel in front of a stone-faced banker to get their money. Nor do they have to wait for the next Fed meeting. All they have to do is pick up the phone — or click on their mouse — and issue one, four-letter instruction: SELL. That Selling Pressure Bonds fluctuate in price almost like stocks. If there are more anxious sellers than willing buyers, the price goes down. Period. Why does this immediately drive UP the yield? Simple: If a bond has a face value of $10,000, it matures at $10,000. That’s how much it’s going to be worth when it comes due. So if you can buy it for, say, $8,000 instead of $9,000, that’s an extra $1,000 you’ll be making on your money. And that’s also more yield a higher rate of interest) on your investment! If you pay $9,000, the extra yield you make will be 11% over the 30-year term of the bond. If you pay $8,000, it’ll be 25%. And if you pay only $5,000, it’ll be 100%. This logic also makes sense in reverse: If the Treasury is offering a higher interest rate on its new bonds, then investors have to sell their existing, lower-yielding bonds at a discount in order to compete. Example: Suppose one day the government comes out with new bonds paying a fixed rate of 10% per year. Suppose you’ve got old bonds paying only 5%. And suppose you want to sell your old 5% bonds to a willing buyer. To compete, you’re going to have to offer your old bonds at a steep discount of about 50%. Even if you paid close to $10,000 for them, all you’ll get is about $5,000. In short, the rate doubled, and the value of your bond fell in half. That may sound extreme. But it HAS happened. And it has happened precisely because of the kind of financial storm we seem to be heading into. There Are More Bets Riding on The $38.1 trillion in debts I cited earlier are almost entirely interest-bearing debts owed by American institutions and American citizens. They don’t include:
That may sound pretty easy. But in real life, it’s anything but. Here’s why: First, the players have made so many bets, involving so much money, it’s mind-boggling. According to the latest report by the Office of the Comptroller of the Currency (a division of the U.S. Treasury Department), just the amount held by U.S. banks is $82 trillion. That’s nearly triple the total interest-bearing debts in the Fed’s report I showed you above. Second, 96% of these bets are concentrated in the hands of just five major banks. That’s not exactly what I call “diversification of risk.” Third — and here’s the clincher 85% of the $82 trillion is riding on guess what! Interest rates! In other words, the win-or-lose fate of these wagers is going to be determined by whether the bettors are right or wrong about where interest rates are headed. The banks argue that they’ll make out just fine. They say they’re balancing their long and short positions so neatly, they’ll never get into any serious trouble. But most are betting on stable rates. They’re assuming no interest-rate shocks. If rates surge more than they’re expecting, many of these bets could turn sour. The banks also argue that the nominal value of the bets greatly overstates the actual risk. True. But the Comptroller of the Currency (OCC) reports that four of the five big banks are taking a risk that exceeds their capital. Moreover, it’s a kind of risk that has little or nothing to do with whether they’re right or wrong about the markets. Here’s where the risk lies: The banks are risking the possibility that their Take Bank of America, for example. For every one dollar of risk-based capital it has in the kitty, the bank has assumed $1.68 in credit risk associated with its derivatives, according to the OCC. Citibank’s risk is worse: $3.10 per dollar of capital. HSBC’s is still worse: $4.07. And the biggest player of all — JP Morgan Chase — now has a whopping $6.25 in credit risk for each dollar of risk capital, based on the OCC report. In a near perfect, predictable world, all this might be justifiable. But in a world of volatile markets and unpredictable disasters, it’s downright crazy. One decade ago, when Dad and I were tracking interest rates together here in Florida, the biggest banks were risking, on average, about $1.50 per dollar of capital. Now, the average is about double, at $3.17. And three decades ago, when I first started tracking interest rates in New York, these kinds of bets barely existed. Plus, remember this: 85% of these bets are bets on the future direction of interest rates. If they’re wrong, it multiplies the potential volatility in interest-rate-related markets. So now can you see why I believe the Federal Reserve is ultimately powerless to control interest rates? Tomorrow: A Unique Crossroad in History A critical turning point may come just 24 hours from now when Alan Greenspan and 11 other members of the Fed’s Open Market Committee meet to decide what to do about their official target for a key short-term rate — the Fed funds rate. If Greenspan decides to stay the course and raise rates by just a quarter-point, thousands of bond investors — wanting more yield to compensate for inflation — will be sorely disappointed. Many will soon rush to sell their bonds. And by so doing, they will drive interest rates higher anyway. If he decides to raise rates by a half point, or if he decides to issue a warning that implies half-point hikes are coming soon, it will be a shock to everyone, especially the five big banks who have been betting on stable rates. They will run for cover, also driving rates higher. To Protect Yourself, I Strategy #1. Keep almost all your cash short term. That way, instead of being a threat, rising rates are a benefit. Strategy #2. Consider putting some money in a mutual fund designed to rise in lockstep with long-term Treasury bond yields.
There are several to choose from. But the largest is Rydex Juno (RYJUX). You can buy it directly from the Rydex Funds with a minimum investment of $25,000 in the Rydex fund family. Or you can buy it with much smaller minimums from brokers such as Schwab and Fidelity. This morning, I took a look at how it’s doing. And sure enough, it’s performing almost precisely as it’s designed to: When the T-bond yield was going down in August, Juno’s net asset value went down accordingly. And with the T-bond yield going up now in September and October, its value has gone up in tandem. Strategy #3. If you have money you can afford to risk, check out options that can go up sharply when interest rates go up moderately … and that can go through the roof when rates go up sharply. These include: (a) options on investments that always respond to interest-rate moves. Examples — Treasury notes and bonds themselves. (b) options on investments that usually respond to interest-rate moves. Examples — stocks in big banks making too many risky interest-rate bets or stocks in smaller banks making too many risky mortgage loans. Just a few hours from now we’re sending our options recommendation designed to capitalize on the Fed’s rate hike, which is going to be announced tomorrow afternoon. So if you’re interested, I suggest you call us this morning at 1-800-815-2917. (It’s too late for online orders — we can’t process them in time for this recommendation.) Good luck and God bless! Martin About MONEY AND MARKETS MONEY AND MARKETS (MAM) is published by Weiss Research, Inc. and written by Martin D. Weiss along with Larry Edelson, Tony Sagami and other contributors. To avoid conflicts of interest, Weiss Research and its staff do not hold positions in companies recommended in MAM. Nor do we accept any compensation for such recommendations. The comments, graphs, forecasts, and indices published in MAM are based upon data whose accuracy is deemed reliable but not guaranteed. Performance returns cited are derived from our best estimates but must be considered hypothetical inasmuch as we do not track the actual prices investors pay or receive. Contributors include Marie Albin, John Burke, Michael Burnick, Beth Cain, Amber Dakar, Scot Galvin, Michael Larson, Monica Lewman-Garcia, Julie Trudeau and others. © 2005 by Weiss Research, Inc. All rights reserved. |
A Unique Crossroads in History
A new and powerful force is about to burst onto the economic scene. 
Some rates have already been rising for over a year. But that was different. 
That’s why housing markets, so hot in the Summer, have suddenly begun to feel the chill winds of Fall. 
For a weekend office, we used the kitchen at my uncle’s Manhattan apartment on 16th Street and 3rd Avenue. 
Nearly three decades later, my uncle was gone, and we moved the office to West Palm Beach. But Dad and I continued to update the same, weather-beaten interest-rate charts we had started back in New York. And again, I can remember very distinctly: 
Most people think the biggest debt-monger in America is Uncle Sam himself. 
Don’t want to hunt around for it? OK. Here’s the critical portion, in black and white. —>
Just visualize the scene: 12 guys sitting in a conference room in Washington D.C., trying to gain some control over this situation … versus … millions of desperate housewives and desperate house husbands all over the country clamoring for their next debt fix. 
partners in the bets may be a bad credit risk and could default on the trade. 
If you own this fund and T-bond yields continue rising (as they have been), you should make money. If yields turn around and decline, you’ll lose money. Previous post: The 4 WORST Investments You Can Make Today
