Are Interest Rates Headed Up?

Not much to say today, with stock markets calm, up slightly (+1% on the Eurostoxx 50). However, interest rates on German government debt are down sharply (-7 bp on 10-year maturities), as the spreads on peripheral nation debt widen (+20 bp in two trading days against Greek debt), which, in principle, is counterintuitive, given the overall good behaviour of risky assets.

Does this prefigure re-dislocation risk -- the re-segmentation that some of our clients already see on certain asset classes, like the yield curves on implied S&P option volatility in the US?

In this context, books, which should naturally try to capture these distortions (Return to the Mean), have lost much of their aura in the past 18 months since they have become largely dominated by momentum books, which is fairly logical in a world increasingly looking toward Asia.

In the game of GO, Sente is the move that signifies initiative, and the person who has Sente most of the time has a good chance of winning.

Surprisingly, implied interest-rate option volatility continues its descent into inferno, which seems very strange for us, since not only are the intraday and daily movements of underlyings largely compensating time value (gamma > theta), but uncertainty as to the timing and method of the exit plans remains as great as ever.

Will they move first on the fiscal front or on the monetary QE? Or will the start off with a hike in financing rates, like in the US?

Has the movement applauding the victory of the monetarists or the post-Keynesians in the great inflation vs deflation debate already occurred?

Obviously not, but the future of long-term government rates depend on its outcome.

Some, more than respected investors, who have all become gold lovers, would have us believe that rates are headed for 6% and above:

• Mr David Einhorn, Greenlight Capital, buying long-dated options on much higher interest rates.
• Mr Julian Robertson, Tiger Management, I think (long term rates) can go to 15, 20 percent.
  
• Mr Paul Tudor, Tudor Investment, Tudor Goes for Gold.
• Mr Eric Mindich, Eton Park, going long gold on a major way.
• Mr Paul Paulson, all his own assets in gold.
• Mr Kyle Bass, Hayman Advisors, Buys Metals on Hyperinflation Fear

Impressive, isn’t it?

But the opposing camp is just as convinced of its arguments, which explains why I am feeling more and more isolated (but markets are not democracies):

• Mr Robert Prechter, Elliott Wave International: Get Ready for a Deflationary Depression.
• Mr Bill Gross, PIMCO, bets on Deflation.
• Mr Rosenberg, Gluskin Sheff, We are certainly in a deflationary state.
• Dr Lacy Hunt, Hoisington Investment Management, Debt deflation debacle.
• And, last but not least, here is Steve Keen in his latest filmed intervention: On the Edge.

You will note that the latter camp appears more academic, but the former surely have more punch, given leverage.

As we await the outcome of this epoch battle, Mr Orodnnez highlighted the issue this morning with his statement that he hoped Spain would used deflation to regain its lost competitiveness. In this regard, check out the graph, below, of Japanese GDP, expressed in both constant and nominal terms.

In passing, Mr Ordonnez added that a hike in interest rates “was not on the radar screen.”

Published this morning, Japanese GDP was up +1.2% on Q3, or +4.8% on an annual basis. In fact, it contracted again in nominal terms, given deflation: -0.3% on an annual basis. The domestic price deflator declined 2.6% annually, following -1.8% in Q2, for the steepest decline since Q3 1958!

So it should come as no surprise to hear Japanese Economic and Fiscal Policy Minister Naoto Kan declare:

I'm worried that we may be sliding into a deflationary situation.

Japan GDP in current (down) and real terms

The impact of deflation…

Comments

[ryanclarke]

With roughly 50 trillion dollars in total U.S. debt and roughly a GDP of 13 trillion dollars ... if Bernake were to raise rates ... the dollar would default. Why ? According to the Economist ... about 40% of the U.S. treasury debt ( about 12 trillion dollars ) will have to rolled over in 2010. Raising short term interest rates by 1% will induce a default on Uncle Sam's debt because Uncle Sam tax income is currently about 2 trillion dollars ... and none of that income is used to pay off debt of any kind.

2009 Nov 17 02:05 PM

[ValueInvestor]

"Are rates headed up?"

Well they certainly aren't heading down. Its just a matter of time before they do. I figure the middle of 2010 (or earlier) is when they start raising them.

2009 Nov 17 04:46 PM

[Dopamine]

US rates will go down, one more time.

2009 Nov 18 02:50 AM

[DONE_SONZ]

If they go up,the economy will go down.Debt will rise.If they stay low,inflation will rise.Win win for gold.

2009 Nov 18 06:24 AM