tonylogan1 (29.13)

Do Not Rec This Blog!

May 06, 2009 – Comments (16) | RELATED TICKERS: TZI , CAL.DL

The following blog is dedicated to herztical, and is being written because I lost a bet last week. I bet TLT would outperform TBT last week. I had my reasons for this, which I will explain, and this blog post will hopefully illustrate where I was wrong, and how very right that herztical was.

As I noted in a March 18th blog, the US is clearly having trouble finding buyers for our long term treasuries. The breakout in treasuries last week further solidifies that notion, and indicates the timeline of our decline may be faster than many anticipate.

The yield on the 10 Year T-Bill rose to 3.20% last week, from a low of 2.54% after the March 18th Fed announcement to buy long term treasuries. The 30 year yield has also risen considerably.

I fully expected the Fed would take at least some action at last weeks Fed meeting, to confirm their desire to keep long term rates low. There is debate as to whether or not the Fed actually has any ability to affect long term rates. I believe they can affect them in the short run, as proven by the dramatic drop in yields on the day they announced their intent to make the purchases. I also believe that they have no ability to control long term rates for much more than a few months at best.

A little mentioned item from the Wednesday Fed meeting was the increase in the frequency of the 30 Year T-Bill sales to now be monthly, rather than quarterly, as it becomes clear that in order to finance all of the “stimulus”, etc, we are going to need to sell a whole lot of debt.

So what does this mean for the typical investor that typically does not follow the bond market?

Well, the Fed knows eventually it is going to need to raise rates to prevent inflation from getting out of control. Bernanke has studied too long the impact of contracting money supplies in the depression era, so we can be sure he is not going to want to pull the trigger very quickly to reign in the helicopter printing press. But, lo and behold, the market is reacting and raising rates on its own.

With world stock markets climbing, the “flight to safety” is leaving, and money is finding a “safe enough” home in a variety of instruments other than US T-Bills (Such as foreign debt, corporate bonds, and equities).

Add to the list of problems, oil and commodity prices are steadily rising. If this does not reverse soon, inflation expectations are going to drive market interest rates up at an even faster pace.

Now comes the part where I need to make some predictions…

To keep the banks from coming under too much pressure, and to avoid having to directly steal the money from taxpayers to the point that pitchforks become a reality, the Fed will take actions that will prop up the housing market.

In his testimony before congress today, Bernanke indicated the housing market is reaching a bottom. Reading between the lines, this means either he believes the economy is going to grow healthy in the next few months, or the Fed is going to do whatever it takes to prop up the housing market.

NOTE: I am not advocating running out and buying a house in the California desert just yet…

To keep the housing market propped up, the Fed cannot allow rates to just rise in an uncontrollable spiral. I would imagine one of the next steps will be for the Fed to issue an even longer term bond like a 50 year. This could serve as the basis for helping to hold up home prices, since it could issue a new era of 40 and 50 year mortgages.

The 50 year mortgage solves all our problems (short-term), by allowing people who are underwater on their homes to be able to refinance into a payment plan they can afford, while it keeps the bank’s balance sheets strong. The banks will effectively own that person’s future. Less than 20% of people will ever pay off a 50 year mortgage. They will die and the house will be sold, and the bank will be made whole on the principal, plus they will have been draining the J6P for interest payments (rent) the rest of their lives.

50 year mortgages will also help sell the glut of housing inventory, since sideline buyers will now be able to afford the monthly payments on the currently overpriced inventory.

This plan is good enough to work, because along with it helping the banks control the next two generations, it also helps government control, since propping up home prices also has the effect of driving up property tax revenue.

There you go. Win-Win.

Not to digress, but where I think herztical went right, is that the Fed fully knew it had no chance at keeping the 10 Year below 3%, so it essentially folded without any effort this week in an attempt to save its ammunition and draw a line in the sand at 4% or higher. Provided the stock markets stay flat over the next month, I would expect 10 year rates to climb steadily and bump up around 4% by the next Fed meeting.

We all know that in the long run (3+ years), interest rates MUST go up, however in real life, I am not shorting bonds and do not advise buying TLT or TBT. I believe the market is about ready to start falling, and when it does, the flight to safety will reveal itself in a short term rise in bonds.

Please for the enjoyment of all readers, I would request the following comments not be included in the comments section:

1. This is Obama’s Fault

2. This is Bush’s Fault