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Are Rising Rates a Warning Shot?

Scheming Bond Vigilantes or Great Buying Opportunity.
 
Since the end of last month, long bonds have been getting killed. The price of the long bond has dropped over -8¼ points and the yield has increased +46 basis points. This is a direct result of one of two things:
 
  1. The markets believe that because of the tax deal and QE2, the economy is heating up faster than anticipated and the Fed may begin tightening monetary policy sooner rather than later.  
  2. The bond Vigilantes are signaling that enough is enough with the spending and increasing deficits, and will force austerity measures just as they have done in Europe.
 
If either is right, then as Jim Morrison once crooned, "This is the end my friend".
 
Regarding the 1st: Once the Fed starts tightening, this economy will be strong as an ox. That is clearly not today, or any time in the foreseeable future. Not only would it stall the recovery but it would absolutely kill what's left of the housing market which is in a verifiable depression. No my friend, they will keep rates low for a long, long time.
 
As for #2, well that is the wildcard. These sinister, evil, cruel so called "Bond Vigilantes" who selfishly want responsible government spending, lower deficits and a reasonable assurance that the government will actually have the ability to pay off its debts, will one day end our party. After all, they effectively forced Greece, as well as most of Europe, to adopt responsible fiscal policies and they will do so here as well some day. However, I don't believe that day is today. With the Euro currently in deeper doo doo than the dollar, the U.S. will remain the world's reserve currency.
 
Therefore, with short term interest rates likely to remain low and not only an absence of inflation but a serious threat of deflation, this is most likely a buying opportunity for bonds. That said, I remain a buyer on the short end, within 2-6 years out.
 
Investor Strategy:
The real opportunity for very nimble professional investors is currently in the stock market. The economic news is steadily improving. ($14 trillion better buy something!) Over the last week, Wall Street has been significantly raising growth forecasts for the U.S. economy following the recent tax deal, with Goldman raising its projections from 2% growth in 2011 to 2.7%, and PIMCO going from +2.5% up to 3%. Given that, earnings estimates will very likely be going up as well.
 
Keep in mind three very important issues:
 
  1. Not all stocks are created equal. There is a lot of hiding and masking going on
  2. This is a bubble, and you have to know how to Play with Bubbles. Bubbles are absolutely fantastic...while they're expanding....but they always....(everybody?)...POP! And then it's UGLY. Keep your personal exit strategy at the ready.
  3. Be sure you completely understand what is going on or are using someone who does. Very simply, be the expert or hire one.
 
  
Regards -Keith  


Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.