As we come to the end of this year, I decided to look and see what happened to the US Treasury 30 Year Bond Yield and the S&P 500 Spdrs ETF in 2013, and how they could impact our portfolios in 2014.
In looking at the 30 Year Treasury Bond Yield chart above, we can clearly see that the low was made on July 23, 2012 at 2.46% yield . Since then interest rates have shot up to 3.19% in the same period. This is a staggering increase in long-term rates putting more pressure on the Feds to be able to maintain a zero base interest rate policy much longer.
In a recent article I published in Seeking Alpha Michael Pento (Pento Portfolio Strategies LLC), made the following remarks regarding short-term rates:
"The bottom line is the interest rates offered on sovereign debt are mostly a function of the credit and inflation risks associated with owning that debt--not the level of growth in the economy, no matter what Wall Street likes to claim. Given the above data, it is clear that the 4% yield on the Ten-Year Note seen back in early 2010 will be eclipsed. Since inflation pressures and the solvency risks to the nation have increased by an average of about 50%, it would seem logical to assume the Ten-Year Note should trade 50% higher than where it was back in early 2010. This would put the Ten-Year in the 6% range, which is still about 100 basis points below the forty-year average. Of course, this is providing the Fed is actually going to end its artificial manipulation of long-term interest rates next year."
As interest rates rise, and in particular in the 30 year bond, the Feds have to use extreme caution as to how much and how fast they implement their "Tapering" strategies without causing another economic crisis of global proportions that would surpass the 2008 financial crisis by causing the yield on the long end of the bond market to rise sharply.
In my last interview with Eric Sprott (Sprott Asset Management), I asked him the following question regarding rising rates...Do you think this will affect the interest payments on the U.S. sovereign debt and what impact could this have worldwide economically?
And he said:
"As you know the debts of all countries collectively have risen dramatically since 2007, so the first fact is that you have to pay interest on the increase of debt but secondly, if you have to start paying more interest on the existing debt and the crush on the budget deficit becomes staggering and I think that the zero interest rate policy was meant to allow governments to continue to issue debt and not have to pay a charge because the decline in interest offset the increase in debt that the interest was payable on. Now all of a sudden the interest rate goes up and the debt continues to go up and you know you're in a catch 22 in terms of when interest payments becomes a much, much larger part of the government budget deficit yet again."
In another article published in Seeking Alpha I made the following comments regarding the Fed:
"The Feds are losing credibility and their balance sheets are making them look insolvent. It is interesting to note that the Feds got rid of most short-term paper to retain only long-term obligations, and as long-term interest rates increase, it further reduces the market value of its principal. The numbers seem to indicate that the expected effect has already taken place as the Feds are leveraged 55 times their net worth. You only need a small move against you to wipe out your principal. As we look at the rise in interest rates since May 2013 (prices coming down), there is a strong case that the value of those Treasury securities has declined by more than the Feds' net worth.
The S&P 500 ETF (SPY) gained 28.5% YTD. These massive gains have been fueled by the zero base interest rate environment created by the Feds since the financial crisis of 2008. Secondly, Quantitative Easing (QE), has provided a "Free Money" environment for financial institutions to put their cash reserves in the stock market and not into the mainstream of the economy. This strategy has only helped a lucky few protected by current monetary policy and not main street where it's needed the most.
Michael Pento made the following statement:
"Thanks to the nearly-free money offered by the Fed during the past several years, publicly traded U.S. Treasury debt has soared by $4 trillion (46%) since the spring of 2010. debt has increased by $1.6 trillion (8.2%) during that same timeframe. And, in the third quarter of 2013 consumer debt jumped by $127 billion, to reach a total of $11.28 trillion-the largest quarterly increase since Q1 2008. Household debt was up across the board with mortgage debt, auto loans, student loans and credit card balances all increasing substantially.
The significant increase in aggregate debt outstanding in the economy equates to a substantial increase in the credit risk of owning U.S. sovereign debt."
Regardless of the staggering amounts of money the Fed has pumped into the economy ($85 billion monthly), the economic growth in terms of GDP has not made that much improvement.
The net result is that the economy has been growing at an annual rate of less than 2 percent. (The latest estimate, that the economy grew at an annualized rate of 3.6 percent in the third quarter, overstates the strength of demand because half of that increase was just because of inventory accumulation.) Weak growth has also meant weak employment gains.
There is more risk now in that the world economies could implode into a deflationary scenario that could challenge the 1929 market crash if they pull the plug too soon or too fast which could have major and profound long-term inflationary consequences. It would be a very difficult environment to continue to support low rates long-term when bond vigilantes begin to demand higher yields in order to compensate for the risk in owning US Treasuries. With $17 trillion tag in sovereign debt, a 100 basis point rise in rates represents an increase of $170 billion in interest payments to service the debt in 2014. A staggering and unsustainable amount by historical standards.
"The same stock market carnage awaits investors just around the corner if the Fed decides it is time to end QE. Only this time the spike in rates won't be caused by inflation but by the central bank itself. It doesn't matter if inflation causes investors to fear that the Fed will raise rates (as it did 1987); or if borrowing costs increase due to the fact that the Fed has to stop its indiscriminate and massive manipulation of the yield curve--the result will be the same."...Commented Michael Pento recently.
The rise in short and long-term rates does not bode well for the world bond and stock markets globally. It would serve well for those that are holding bonds or have substantial profits in stocks to begin taking some profits off the table or to hedge their positions as the low rates mentally inevitable will come to an end - sooner than later.
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