We are certainly living in interesting financial times marked by great volatility in the usually stable bond markets. This volatility is being driven by some dramatic shifts among economies in recent days.
For example, the
European Central Bank /ECB is perceived to be getting more loose with its monetary policy at a
time when the FED is starting to look like it’s going to tighten. Since
gold is priced in US dollars, the strengthening $ vs Euro (based on
changes in trend between the FED and theECB ) is causing gold’s price to
fall in dollars.
One other fine point, and that is rising US
interest rates are perceived to be a drag against gold–at least, it is
clear that the Quants who program the trading machines view it this way.
However, there is an old school of thought which dates back to the
1970s which says that as interest rates rise, it becomes a harbinger of
coming inflation, and therefore, gold should be rising. (In the late
1970s and even into the 1990s, interest rates and gold often rose in
tandem.) That is clearly not the way the Quants have programmed for now,
so one needs to be aware that as interest rates are rising, gold will
continue to sell off until the Quants change their formula.
TLT has started another leg down, and I almost pulled the trigger on
some new buys of TBT calls (TBT is the 2x short ETF) on Wednesday, but
because of the holiday yesterday, I hesitated….wish I had made that
move now as the TLT gapped down out of that bear flag I had shown the
board here a few days ago! Still, as I see it, it might still be a good
enough time to jump in on TBT calls if there is a little back-filling
here but probably not today….let it try and struggle back some from
the gap low for a couple or three days, is what I am thinking now.
if one is trying to pick a bottom in the TLT downturn, the H&S
breakdown is projecting a bottom at about 96.5 and the current price at a
little under 108 still leaves plenty of room to go before the target is
One other interesting observation: the
yield curve is flattening since April (though still with a pretty good incline). A flattening yield curve tends to be more bearish for stocks. Also, this implies that short term interest rates are moving up at a
faster rate than long ones (especially 1, 2 and 5 year rates appear to be moving up faster while very short term notes like the 30 and 90 day remain near zero).
mind that the Fed has basically jawboned short term rates to near zero
with a simple communications strategy as the Fed has been buying very
little short term paper (and it allowed its previous short term holdings to expire so they could rotate monetary proceeds into long bond purchases) ….which also leaves open the possibility, as
unimaginable as it may seem, that the Fed could lose some control of
the short end of the curve.
Now, in theory, the Fed could never lose control of the short end of the yield curve because it has the power to create money which can be used to buy short term notes. The hidden risk is that currency markets would perceive this sort of monetary practice as reckless and could punish the dollar somewhere down the road.
Could it happen? It might have just happened in China, where the People’s Bank of China (PBOC) had to rush an infusion of money into their economy because short-term interest rates suddenly spiked causing a few days of angst in that juggernaut economy. As the PBOC proved, a central bank can rush in to fill the void on short term paper very quickly.
Of course, the PBOC is backed up by some $3 trillion in monetary reserves, unlike the US government which is in debt by at least $16.8 trillion (or more if one lumps in many other debts). The US central bank (technically separate from the US government) itself has a relatively small amount of capital reserved against its assets (debt paper holdings) to offset any dramatic changes in rates.
However, I am getting ahead of myself. For now, the game is that the US dollar is king, because US equities have rallied in 2013 while the rest of the world suffers through various stages of austerity. As the month of July progresses, it appears we must believe that the US economy is returning to its former 20th century glory as the rest of the world looks on sheepishly and with envy. It sounds great, especially to an American citizen, myself included.
Does this mean that all the growth in developing economies over the past quarter century was only an illlusion?
Now, please don‘t wake me from this fairy tale dream!
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