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Over the last several weeks, I’ve been steadily ratcheting up my warnings on the interest rate front. On April 25, I noted that the “Bond King” Bill Gross believed Treasuries were overvalued — and that he was aiming to profit from a decline in bond prices (and corresponding rise in yields). My message for you …
“Gross is betting on the same thing I’ve been warning you about for some time — that bond prices will fall and interest rates will rise. The market’s recent action suggests that’s just what we’re going to see.”
Then several days later, on May 9, I got even more explicit. I warned you right here that “The bond market is on the brink.” Specifically, I said …
“Bonds are right on the brink of a significant technical breakdown. An uptrend in long bond futures prices that dates back all the way to last June recently gave way, and now, bonds are testing their 200-day moving average.
“If this area of support fails, I think we could see a quick, nasty fall of as much as five points. Yields on the benchmark 10-year Treasury Notes could spike sharply.”
This week, the breakdown I’ve been talking about has gotten underway. If you haven’t already acted to protect yourself, you can’t afford to wait any longer!
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The charts tell the story — bonds are in big trouble
I’m a fundamental analyst at heart. But I also pay a lot of attention to the “technicals” — what the charts show. Look at this chart below of the long bond futures and a few things should jump right out at you …
First, we cracked through a multi-month uptrend in mid-April. That’s labeled “Break #1” on the chart.
Then, we sliced through the 200-day moving average. That’s labeled “Break #2.”
Now, it looks to me like we have NO significant support until the 110 area. So we could drop that far in a virtual straight line. If we do, that means bond futures could potentially shed 12 full points from their January high — a big move for bonds!
The fundamental reasons behind this move should be very familiar to you by now. But to quickly recap …
- Rates are way too low given the current level of inflation.
- The Federal Reserve has slashed short-term rates to the bone in an effort to save the financial system. But in the process, it has unleashed a mammoth wave of commodity inflation.
- Meanwhile, inflation and economic growth remain strong outside of the U.S. That is pressuring interest rates higher — and bond prices lower — worldwide.
What falling bond prices mean to you!
Many people think about bonds in terms of their interest rates, or yields, rather than prices. So let’s shift to that side of the ledger.
Yields on the benchmark 10-year Treasury Note have already risen from a low of 3.31% in mid-March to around 4.12% now. If I’m right about where bond prices are headed, 10-year yields could shoot all the way up to the 4.5%-4.75% range.
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That’s important for a couple of reasons …
1) Long-term mortgage rates aren’t directly controlled by the Fed.
Bond market traders and investors determine where they go. When investors are confident about the outlook for credit quality and inflation, they buy mortgage and Treasury bonds. That drives rates down. When investors are worried about rising credit losses and rising inflation, they sell. That drives rates up — or at least prevents them from falling much.
Just consider: The Fed has slashed the federal funds rate by 3.25 percentage points since last summer. But the average rate on a 30-year fixed mortgage is hovering right around 6.08%, according to Freddie Mac. That’s down only slightly from the 6.3% area at the beginning of last September, when the rate cutting campaign began.
Now, bond investors are turning into aggressive sellers. So I’m expecting rates on 30-year fixed mortgages to start RISING. In fact, I wouldn’t be surprised to see them head into the 6.5%-6.75% area over the next couple of months. That’s exactly what borrowers who are trying to refinance — and shoppers who are trying to buy homes — DON’T want to hear. But it is what it is.
2) The Fed usually follows the bond market.
The Fed rate cuts haven’t done much for people who are hunting for 30-year fixed mortgages. But they have brought down the cost of certain loans, such as home equity lines of credit. That’s because these loans feature rates that adjust to the prime rate, and the prime rate follows the federal funds rate in lock step.
The Fed cuts have also driven down the London Interbank Offered Rate, or LIBOR. That, in turn, has reduced the magnitude of the rate and payment increases that certain subprime and prime Adjustable Rate Mortgage (ARM) holders have had to cope with.
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| Federal Reserve Chairman Ben Bernanke’s attempts to solve the U.S. credit crisis by flooding the market with dollars may end up backfiring if fixed-income investors lose confidence in the Fed’s ability to fight inflation. |
But here’s the thing: The Fed pays attention to market signals. If bond prices start falling fast, Fed policymakers will interpret that as a sign that fixed-income investors are losing confidence in the Fed’s inflation-fighting resolve. And they’ll react — first by trying to “jawbone” the market and second, by actually raising short-term rates.
Don’t believe me? Look at how many Fed speakers have paraded in front of various podiums to re-iterate the Fed’s inflation-fighting mantra. Dallas Fed president Richard Fisher was only the latest, saying yesterday in San Francisco:
“If inflationary developments and, more important, inflation expectations continue to worsen, I would expect a change of course in monetary policy to occur sooner rather than later.”
The Fed clearly won’t be cutting short-term rates again when it meets on June 24 and 25. But the more important question investors should be pondering is “When will the Fed start HIKING rates?” I think it could be sooner than the market expects.
Hopefully, you’ve been heeding my warnings and moving money out of long-term bonds. I can’t stress enough how when bond prices start to fall, and interest rates start to move, they tend to do so with gusto. Protect yourself!
Until next time,
Mike
P.S. Our Safe Money Report subscribers are well-prepared for the coming bond debacle. They own a fund that’s designed to RISE in value as bond prices FALL. Want to join them? Just click here for a special discount offer.
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