My belief is the Fed will be foolhardy to raise interest rates in September, with China dumping its treasuries. By selling their US assets, China is forcing interest rates higher, especially on the 10 and 30 year treasuries. The only reason the long bonds aren’t rapidly losing value is that we are in the grips of a new bear market, and stock investors are fleeing to the relative “safety” of bonds. Yet, bonds are failing to reach new highs because of the overseas selling of them.
By the way, China’s dumping of US treasuries has created QT….Quantitative Tightening! In other words, China has acted ahead of the Fed!
But this is QT in the worse way possible because selling tons of long bonds into the open market can create huge pressures on the debt and credit markets as well as equities–in effect, market disequilibrium! In the past, when the Fed raised rates, they would sell short term treasuries into the open market….but never long bonds! This QT by China with the long bonds is doing the work of the FED by raising rates (on the long end of the curve) even before the FED can act at its mid-September meeting. However, the sale of long bonds creates undue pressures on mortgage markets and other longer term markets in this country.
And China holds a lot of our treasuries ( and they can disrupt markets if they sell a lot of these). This is why I own one call on TBT….and I may buy more.
And I am keeping a close eye on gold because investors could suddenly lose confidence in owning bonds…..that could cause a dumping of the dollar and nearly all other assets….so, I suggest to keep an eye on gold for any sudden breakouts.
Tick-tock…tick-tock…goes the countdown clock toward the August 2nd date when the US Treasury has said it will no longer have enough money to pay all of its bills on time. The raising of the Debt Ceiling for the US government is the issue at hand…and now, suddenly it’s becoming front page news.
For many weeks, I have warned that we would be coming up on that date with financial Armageddon without any political resolution…I encouraged investors to consider moving at least a portion of their Cash Sweep Accounts or any of their money invested in CDs, savings accounts, money market funds and bond funds and move those funds into foreign-based investments including Swiss Francs (the ETF symbol is FXF), the Australian dollar (symbol FXA)* or gold/silver bullion (my favored fund is under Amex symbol CEF and secondarily into ASA or GLD, though I have some reservations about GLD).
I have had people tell me I have lost my sense of direction in the markets….others have called me “a goof” and have said that it will never happen! The US will never default on its loan obligations…and they have told me that the US dollar is not about to lose its reserve currency status for at least another generation.
Some investors (and “enlightened experts”) have told me that if there were any trouble with the US suffering a technical default on its bonds, we would be seeing rising yields and a rush out of bonds…they point to actions that are just the opposite…bond yields have fallen in recent weeks and bond prices have risen to 2 year highs. They proudly proclaim that “the smart money” is not running in fear of US Treasuries, but rather, its embracing them.
Their argument is a good one! ..and up until now, except for some substantial gains I have experienced in some gold trades in recent days and some decent return on my sizable, but “temporary cash sweep account” investments in FXF and FXA, since starting a buy program in both several weeks ago…the so-called experts have been right. Financial armageddon has not occurred in the US…and those bond yields are historically very low.
Indeed, there has been talk swirling about, mostly from the conservative “tea party” side of politics that a technical default by the US would be “a minor event”…and that such an event might make for a great tactical weapon in forcing the hand of the Democrats and Obama to give in on spending cuts in a more meaningful way. Such speculation, trumpeted by Congressman Paul Ryan and encouraged by the likes of Representative Cantor and many other tea party supporters, puts forth the notion that a technical default by the US would be only temporary and would do more good in flushing out the same old game of spend, spend, spend by the Democrats.
…at least this is the notion being bounced around!…and as the pollsters have demonstrated, the idea of a forced technical default has the support of the majority of American citizens.
Indeed, the citizens reason, why should the government be allowed to spend beyond its means and act like a drunken sailor with a credit card, when the rest of us are held in check with our own household debts and expectations of maintaining some semblance of money management?
What the public doesn’t quite seem to grasp is that “high finance” of the likes run by our Federal government is not one that can operate well under the same rules of finance that apply to individual households….moreover, what particularly perturbs me is that many of our elected officials in Washington (read “Tea Party”) are also operating under the same notion that a balanced budget must be forced upon our government…and that the only way to cure the economy’s ills is to drastically cut spending.
It is the naive understanding of the general public…and the equally naive thinking of some members of Congress that makes for a particularly scary situation that we face as the August 2nd deadline approaches.
To you, dear reader, do you understand what a technical default might mean for the US’s standing in the world? Do you, dear reader, understand that a default could have very serious consequences for every American? Every man, woman and child in this fair land of ours? Do you know that 97% of money market funds in this country are invested in US treasuries? Why? Because they are supposed to be as safe as grandma and applie pie!
Unfortunately, I have only limited space to say all that needs to be said on this subject…but I can summarize matters by refuting some of major points of the Tea Party leaders and their crowd and of the so-called experts of high finance who say that there is no worry in the markets about a technical default….so without further ado, let me try to explain the flip-side argument to each of their points:
1. “It will never happen! The US will never default. They will come to some kind of agreement.”
Re-tort: This is all I have heard for many weeks, yet here we are only days away from a technical default and neither side seems ready to give in to the other side. I have already won this argument…those who questioned this warning of mine with such “vim and vinegar“, go ahead and eat your hats!
2. “It’s just political posturing…okay, maybe this thing goes down to the wire, but one side or both sides will eventually cave into demands…and the debt ceiling will be raised for the time being.”
Re-tort: Oh??? Okay, though that hasn’t happened up until now and both sides still seem far apart, let’s just assume that they do extend the debt ceiling by August 2. Do you think the problem will be swept under the rug? Let’s face it, if an extension of the debt ceiling is granted, it will probably be viewed as a band-aid and a further kick of the proverbial can down the road…if so, do we face the stark reality of the ratings agencies like S&P, Moody’s and Fitch down-grading the US debt anyway? And if and when our AAA credit rating is lost, how much will interest rates rise in this country?…that will be like a burdensome new tax on the citizens of this country!…and unlike a Washington imposed tax, most of this tax will be sent to our creditors overseas! Interest rates will rise on mortgages, credit cards, car loans, etc!…Americans will encounter a whole new series of cost increases in an economy that is anything but robust as it is…. And what about the many states in our union and their own credit ratings which are backed by the US AAA rating?…and what about our financial institutions that rely on a AAA sovereign debt rating of the US government? Banks, insurance companies and many pension funds are heavily invested in US treasury paper.
3. “Oh, so what if the ratings agencies say our debt is down-graded a notch? This has happened before to many sovereign nations, and little damage has been done in most cases.”
Re-tort: But this isn’t just any nation defaulting…this is the largest government economy on the face of the earth that would default!
Do you accept there is a law of gravity? If yes, then you should know there is a financial law of sorts that says that the US treasuries are the safest place to invest one’s money on the face of the earth. US bonds are supposed to be like the sun rising every morning! Like the law of gravity! They are “there.” They are dependable…always!
BUT, with a technical default, it would be like Dorothy discovering that the Land of Oz is ruled not by a great wizard, but rather by a droll little man hiding behind a curtain! The let-down would cast a funky spell over our creditors…and destroy the faith of investors worldwide!
4. “The so-called financial experts from top think tanks in Washington to the veteran hands on Wall Street point to the fact that the yields on US treasuries have held steady, and even dropped in recent days as if to say that the bond market does not view the US Debt Ceiling debate as a threat
Re-tort: OK, they seem to make a good point…but wait, one major reason the US treasuries have gone up in price (and yields have dropped) has to do with the equally bad credit situation in the sovereign nations of Europe. So, scared money has to go some place…and I believe a lot of that scared money doesn’t really know WHERE to go? …so, like Pavlov’s dogs, that scared money does what it has learned to do in the past…seek the safety of US treasuries…they’re still safe, right?
BUT, this specious argument misses some key warning signs…for one, the US dollar has continued to erode against the Euro…if Europe is in such dire straits compared to the US, then why is the Euro at near historical highs against the dollar?
And why is the Australian dollar at such strong position against the US dollar? Could it be that the Australian dollar of a country with vast natural resources is viewed as a proxy for China’s vibrant economy? (Conversely, notice that the Canadian dollar–sourced from another vast resource-rich country– is much weaker than the Aussie dollar, because Canada’s major trading partner is the US!)…and as manipulated as the bond market has been in the US the last couple years, can we really count on the bond market to tell us that everything is going to be all right? I think the bond bulls are missing the signals coming from the currency markets! If all is right with the US economy and our sovereign debt, then the US dollar should be strengthening against other currencies, especially the euro…but this is not what we see!
5. “Look, if the technical default causes a freeze up of credit or in some way causes money markets and bond funds to lose value, the FED will step in to provide liquidity…just like they did in September of 2008!”
Re-tort: This argument is a favorite of the economic experts from the finest think tanks and universities across our land–that somehow, if things spiral out of control, the man who saved the economy once before, Ben Bernanke, will show up on his white horse again–ready and willing “to prime the pumps” with lots of liquidity! Of course, liquidity is a nice little word for saying that the Fed president will be printing lots of money…and we all know that the US debt is backed by the full faith and credit of the Federal Reserve.
However, just like the US treasuries are now being called into question as AAA paper by some ratings agencies, what leads us to believe that the rest of the world will still accept the Fed as the only financier in town? What is that the FED owns that gives it it’s special powers?
If I may borrow that Land of Oz analogy again, what happens when our largest foreign creditor, China, pulls back the curtain on Ben Bernanke? What will it find?
Loads and loads of debt paper is what it would find…money that is owed by our US treasury to the Fed…money that could be called in as “due all at once because of a technical default”…well, does our Treasury have $14.3 trillion laying around that it can pay off this debt all at once? Not unless the Fed prints off that much…and what would China, Japan, and Russia, three of our largest creditors say to that?
Also, consider the largest holder of US treasuries is not any foreigner at all, but our own Federal Reserve…and the Fed also owns lots of damaged mortgage paper that it has accumulated the past couple years to try and stop the hemmoraghing of our banks, pension funds and financial
institutions…what will the world think if it begins to question its faith in a central bank that owns nothing but debt paper, most of it US debt that can’t be paid back overnight or even 20 years from now…which goes to point up the fact that the FED draws its power and strength from the world’s faith in it as the depository for the world’s reserve currency.
But what if that faith is suddenly shaken as the curtain is drawn back on the Fed’s pile of debts?
Could China play its trump card in year 2011? I never thought that such a moment could come so soon!…but it is China that holds a very strong, positive balance of trade…it is China’s government and its citizens who own so much gold…and have few debts (though there are surely some debt-ridden banks in China, the aggregate debt situation of these banks pales in comparison to our overall debt exposure in the US)…
It is China that has a burgeoning military that already threatens the US dominance of the Pacific rim nations…it is China that is owed so much money from the US (and other creditor nations too)…and if the US defaults on its debts, China has the wherewithal to “write off these debts” and still have a much better financial position than that of the US once a technical default happens.
Which all goes to point out how critical it is that the US government at least reach some sort of temporary extension of the Debt Ceiling in the next few days…otherwise, I can guarantee you that things will not be pretty here in the US.
Again, the argument goes that the Congress and the President would not be so dumb to let our government default on its debt–but I believe that there are roughly 80 to 100 members of Congress who don’t understand how world economics works…and I worry that our own president does not fully understand the situation at hand either, though I am sure his advisors have warned him.
Those who up to now have ignored my calls of seeking safety in foreign currencies, foreign bonds (or bond funds) or in gold and silver, I say, you may be the ones left standing on a street corner in the proverbial barrel on suspenders… but I hope not, dear reader!
I hope I am wrong about this bad feeling I have…I hope for once that the majority is right…and I am wrong…for if I am way off base, I think I will still have money left when I bail out of the Swiss Franc ETF and the gold bullion funds…and you can say “I told you so.” Yes, I would welcome hearing that once...to know that the American Dream is still intact?…rather than being on the precipice of a 21st century dark age where the ruling countries of the world will be led by communist leaders. I cannot fathom a world led by such a ruling class…for the future of our children and grandchildren!
*post-script 7/23/11: Some currency traders I have listened to recently suggest that the Aussie dollar will fall rapidly on a US debt default or downgrade. My reasoning for including the Aussie $ in this protective move has to do with its trade connection to China. In other words, in a worse case scenario, my thinking has been that money would seek safety in Asian assets, which the Aussie $ is the only “western” currency that is closely intertwined with China and Asian trade. The currency experts speak of a Aussie short against the Swiss Franc, but curiously they do not mention a US $ short against either. Keep in mind that FXA (and FXF) are currency ETFs that are priced in US dollars, and so they are a play on the US dollar against the Franc and Aussie buck. This being duly noted, and the fact that I am not a currency expert, only speaks of how much uncertainty there is out there for the right protective strategy. However, if enough currency traders are of the opinion that the Aussie $ might collapse, I would suggest lightening the investment in FXA and staying more to gold and FXF.
FXF- Swiss Franc ETF
CEF- Gold and Silver Bullion Fund
GLD- Gold certificates
IF Greece should default, are you prepared with “the insurance stocks” above if your CASH SWEEP ACCOUNTS are frozen next week?
Did you know that up to 45% of Cash Sweep Accounts are invested in European Bank and European Sovereign Commercial Paper?
Will the FED come to their rescue like they did in 2008? Or more likely, can a damaged FEDERAL RESERVE holding $Trillions in worthless Mortgage-backed Securities and other highly suspect debt paper be in a position to rescue the world’s money market funds again???
I find it ironic that “the safety trade” is to seek out US Treasuries and US dollar assets?
…and should the US suffer a technical default on its debt soon…or just come close with the political wrangling in Washington, then how is an investment in the US treasuries and dollar-based assets a safe place to be???
We may be on the precipice of one of the most tumultuous financial earthquakes ever….and people are seeking safety in the very assets that may be most at risk.
As I stated over a month ago, watch for the 20-85 downcross on the TLT (long-dated US Treasury ETF) chart….that down-cross occurred about a week after my illustrated scenario (which was not meant to be an accurate forecast at the time). Once that cross occured, it didn’t take me long to get into some TBT (shorts long-dated US Treasuries) calls on the options market.
Sure enough, most of my BIGGEST gains the past 7 days or so have come on the TBT calls….I sold some off for triple-digit gains….and kept some too….also took part of the profits and rolled them over into longer dated, slightly more out of the money calls to save on premiums and at the same time, be in position for further big gains.
Now, some options experts would tell me that I’m living dangerously by buying out of the money calls to save premium….but if they were as good at reading charts as I am, they might understand my “madness.”
As of this date (a Saturday in mid-November), we have the TLT resting on its 200-day line, and well under the 20-85 downcross. I’m watching to see if the 200-day line gives way? If so, then I think this downtrend continues.
So, what is going on with the long-dated Treasuries? In short, there are two major themes at play here, I think. One is the the FED’s QE2 bond-buying program is concentrating on shorter-term bonds as compared to the 30 year ones (this was actually stated in the Fed’s policy). Second, we have the Chinese, a major buyer of our bonds, moving away from US Treasuries and more into hard assets like commodities. So, with two major buyers moving away from the long-dated treasuries, there is great potential for the long bonds to continue with a rising yield (and fall in premium value).
However, there appears to be a third reason here: lately, asset prices of everything in our country seem to be rising. In other words, inflation is creeping into the US, despite Fed observations to the contrary. The weak dollar policy of the FED has caused a spike in gasoline and every day staples that rely on input costs of basic materials which are rising in value. When inflation creeps in, it causes the long end of the yield curve to rise…and that is a phenomenon we are beginning to see, despite FED attempts to keep treasury prices down on the 10-year note…and somewhat on the 30-year bond.