Interest Rate Update

The yield curve is at ALL TIME historic wide spreads. This means that short duration debt is yielding very little while at the same time yields/rates are rising DRAMATICALLY on the long end of the curve.

TLT, the 20 year bond fund, has fallen in PRICE by 25.9% since its pre-Christmas high. Call it whatever YOU want, I call it a BOND MARKET CRASH. Anything that loses a quarter of its value in only five months has CRASHED. This crash was the result of a parabolic rise in bonds. ALL exponential math eventually crashes upon itself (Spend some Time with the Good Dr. Bartlett).

This parabolic growth was noted in this article: Bond Market Hide & Seek – A Domed House & 3 Peaks Consider this post an update to that article.

Note on the following chart of TLT that we have now retraced 100% of the final blow-off top of the parabolic move and are now basing right where I drew that line 5 months ago (on this chart PRICE is on the right):

Now let’s zoom out to a two year chart and at the very bottom you see a rising black trendline… that line is the long term growth line since the inception of TLT in 2002:

It is the same growth line that really emanates from the peak in interest rates back in 1980. They have been falling ever since then and just hit ZERO! Thus, there is nowhere to go BUT UP (for rates)! And up they have gone, TLT lost 25% already! But watch that trendline down at 87.50… When/if it breaks, then you know for certain that the long term downtrend in rates is OVER and that higher rates are on the horizon. It’s my belief that that is going to happen soon, probably following some basing action between here and there.

Below is a chart of the TNX going all the way back to 1962, almost my entire life. The TNX represents the 10 year Treasury notes which most FIXED mortgage rates are tied to. You can clearly see that rates rose into 1980 and that they have collapsed to an all time low near 20 – that’s 2% on this chart (on this chart RATE/YIELD is on the right):

And now rates have almost DOUBLED since that low. The question, then, would be is that as low as it goes, was that THE bottom? The answer is YES, that was and will remain THE bottom in interest rates. WHY? Because the Federal Funds rate cannot be intentionally set below ZERO and the 10 year must yield at least 2% more than the Federal Funds rate or otherwise the banks cannot possible make money by loaning money (what a concept). So, you have seen THE LOW for your lifetime, I doubt that you will see it again.

Let’s go back up to that chart. See that trendline I drew in? 10 year rates above that trendline, about 4.8%, will mark the end of a 30 year era of decreasing rates. That era was marked by LEVERAGE. As rates went down, borrowing money became more and more affordable. This, in turn, caused the PRICE of all ASSETS to gain in value. The zero percent Federal Funds Rate would have never happened had it not been for the securitization of debt process and the shadow banking world of derivatives. That era has peaked and a break of that trendline will signal that the era has indeed ended (the break of that trendline should correspond to the break of the lower trendline on TLT). It’s going to happen, it’s just a matter of WHEN. That I do not know. The faster equities rise and the more Bernanke prints, the FASTER it will happen!

Here’s why it matters… we are already a debt saturated society on all levels, personal, corporate, local government, state government, federal government (Death by Numbers)! The higher the cost of borrowing goes, the greater the income that has to go to servicing all that DEBT, and the less money there is to actually buy goods and services (When the Math No Longer Works). People can afford to buy far less house at 9% than they could at 4.5%!! This will keep the trend of falling asset values alive.

Thus, we are leaving the 30 year era of leverage where DEBT was your friend. When rates are rising, you are in an era of deleveraging where DEBT is YOUR ENEMY! How long will that era last? Well, let me put it to you this way… look at that chart and you will see that it has just started! Of course NOTHING moves in a straight line, so there will be headfakes and bounces along the way. And, I would not be surprised to hit that trendline and bounce off it before breaking it. Heck, a rise in the TNX to that trendline will ruin our over-leveraged middle class, especially if our dollar is losing value at the same time and robbing the same people of more purchasing power.

Think the crisis is over? Think again. Yes, rates rising WOULD be a “good thing” IF we were not saturated with debt, but we are. This is a new era we are entering, it is CRITICAL that you understand the difference between an era of leverage or one of deleverage!

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