August 20, 2013
Fed “tapering” doesn’t matter…
Seems like every other word by the talking heads right now references “tapering” and its resulting implications for stocks, bonds, interest rates, the economy, emerging markets, etc…You name it and all those painted faces can give you a ton of “logic” as to the ensuing effects of the Fed slowing their own buying of US Treasury and mortgage instruments…with the OVERWHELMING majority of opinion being just dead certain that “rates are going up”.
I TOTALLY, TOTALLY, TOTALLY DISAGREE. I STRONGLY BELIEVE WE HAVE ALREADY SEEN THE HIGHS IN LONG TERM RATES, FOR, AT LEAST, THE NEXT YEAR OR SO, AND CONCURRENTLY WITH THAT, JUST AS STRONGLY BELIEVE WE HAVE SEEN THE LOWS IN TREASURY BOND PRICES.
I AM AGAIN BUYING THE DECEMBER TREASURY BONDS, USING BOTH FUTURES AND CALL OPTIONS, LOOKING FOR, MINIMALLY, A 12-15 POINT RALLY ($12,000-$15,000 PER FUTURES CONTRACT) BEFORE WE GET TO 2014.
The Fed is not the only factor in the Bond market. As I have pointed out before, the average daily trading volume in Bonds, in the United States alone, is somewhere in the range of $800 billion…A DAY…Throw in the rest of the planet and I can easily imagine you are then talking probably double that number or $1.5 trillion (a guess)…again…DAILY…so if the Fed starts backing off their buying by 15% a month, meaning $12 billion less…A MONTH…it is just a drop in a very big bucket.
And just to put this in perspective, the following paragraph has been copied from a previous newsletter…
THE FACT IS: EVERY DAY, ALL OVER THE PLANET, THERE ARE MANY, MANY BILLIONS OF DOLLARS THAT HAVE TO BE INVESTED IN SOME KIND OF BOND OR QUALITY FIXED INCOME. Whether it be pension funds, or banks, or insurance companies, or governments, or individuals or whatever…EVERY day there is a mountain of money that cannot just sit there earning nothing. Whoever is responsible for investing or reinvesting those funds HAS to do so, that same day (generally) at whatever the current rate may be. They cannot, for example, say to themselves, “I don’t like the current rate. I think I’ll wait until it gets better”. They HAVE to pull the trigger and invest the money. MANY BILLIONS, EVERY DAY…So I assure you, if the Fed were to say, “ We are going to totally stop buying Treasuries tomorrow” (which is not the case…they will “taper” their buying over time), it would still only be a drop in the global bucket as to what is out there waiting on the buy side…Again every day,…So the point is, contrary to all the supposed expert and media “logic” you hear, just because the Fed is going to slow down and eventually terminate their buying does NOT mean that bond prices are going to fall off a cliff due to no demand for the instruments…nor that rates are going to go rocketing higher. There is a TON of daily demand for US Treasury Bonds, otherwise known as THE safest piece of paper on the planet.
I feel relatively safe in believing that the demand for borrowed money, which has certainly been a factor in pushing rates higher, has probably peaked for the current year…Think about it…The investment and media world is now all hopped up about the release of tomorrow’s Fed minutes (from their last meeting), in which it is widely accepted they will reveal their plans to begin the tapering process...which is just as widely accepted as meaning, “Rates are going up”. This opinion has been out there and growing in fervor for months, to the extent that I would guess that just about every potential long term borrower for 2013 has by now closed on all their interest rate deals.
For example, suppose you are running a company that is interested in expanding or modernizing its business, and to do so means building a new factory, which is generally done with borrowed long term money. So, when that executive KNOWS, according to every media and economic forecasting unit on the planet, that “Rates are definitely going higher” (maybe even “SPIKING”), he also then “knows” that every month, or quarter, he waits may result in increased borrowing/building costs…maybe even gigantically so (spiking). So what do you do? You get the borrowing done...You don’t wait.
This is obviously a simplification but it is a very real synopsis of what does actually take place in the corporate world…People DO rush to “get the deal done”…and when you multiply that sentiment across the country, and realize that every single company who does have any intention of growing, is making the same decision (and they DO), the cumulative effect can easily be that across the nation, a mountain of borrowing gets pushed through the door, all at once…which in itself can help push rates higher as all that “demand” for money hits the market at relatively the same time…Rates go up. Bonds go down…and along with it you get more of an avalanche of opinion screaming “Rates going higher!”.
But then what happens?
Lenders make their money by lending. When they are sitting there with customers knocking the doors down to borrow, they are just fine. They can even ask for a higher rate (“Just an eighth higher than we anticipated , Mr. Jones. Rates are headed higher you know.”) because they have plenty of customers, thus contributing to the rise in rates that HAS been taking place…But…once all that business is done, what do they do? They need to lend…so the next phase in the process becomes a scenario involving the banker calling Mr. Smith with something like, “Hey Joe, whatever happened to that build-out you were planning? If you are still interested, things have slowed down here and maybe we can give you a little better rate now. Come on in and let’s talk.” And so starts the pendulum swinging back in the other direction…towards LOWER interest rates…at the very same time when everything you read, in classic market fashion, will be suggesting exactly the opposite…as is the case right now.
At this moment, with traders and investors now waiting for the Fed’s minutes, and all of them so definitively certain that “Rates gotta go higher!” (after they already have), and “Bonds gotta be headed lower!”, all I can say is, “I have been here before”. The truth is, I really don’t know how many times I have seen this very same set up during the past 33 years following the interest rate markets, but in a nutshell, I am rip roaring bullish this market. I THINK THE TREASURY BOND MARKET IS A BUY. RIGHT HERE. RIGHT NOW. RIGHT IN FRONT OF, AND RIGHT AFTER, TOMORROW’S FED MINUTES.
I could give you more of my reasoning, pages and pages of it as many of you know, but the night is arriving so I’ll just make the charts and finish this…
I AM BUYING DECEMBER 2013 TREASURY BONDS, USING BOTH FUTURES AND OPTIONS. I WOULD NOT BE SURPRISED TO SEE 150 (20 POINTS AWAY) BY YEAR END. SERIOUSLY.
This is my own opinion, but in my mind, there are ONLY three things that could even begin to suggest a truly higher (than now) interest rate environment:
One – The Fed actually RAISING short term interest rates. Not even close as option. All tapering means is they won’t be “easing” as much…And if they did raise short term rates, it would take a MASSIVE jump before it impacted long term interest rates.
Two – A substantial economic downgrade of the USA as an entity. NOT going to happen.
Three – Hyperinflation. The everlasting dream of all the gold bugs on the planet. I’ve been hearing about it as a possibility, FOREVER, yet it never appears. I mean, really, we’ve had numerous eases, and infusions of capital, by the Fed and other Reserve Banks, for decades, all of which were supposed to rear the ugly head of inflation, but it hasn’t happened. In fact, or in my mind anyway, for a NUMBER of reasons, deflation is more of an ongoing possibility that inflation. Bottom line is, the following chart says it all…that if we haven’t experienced “rampant” inflation for the past 30 years, it’s probably not even remotely on the horizon now.
Here is one option (among many) I like…
There are any number of ways to go about this, including variations on the 2 & 1 options strategy, or by simply buying the futures contract with a corresponding at-the-money put…Essentially though, I just say you enter this market at current levels, with whatever approach you want to use. Do it here, in the hole, right now, when every headline I can find suggests doing exactly the opposite.
And a message for those of you who have known me going back 15-20 plus years (or more): To me, this is the same old bond market we caught in a big way on more than one occasion (and some when I was wrong as well) during the 80’s and 90’s…And I may be dead wrong, but I think this trade has the same sort of major potential. Having seen more than a few bond “lift offs”, right in the face of overwhelmingly negative “expert” opinion, I think this moment is no different and we could easily be 6, 8 or 10 points higher by mid-October…and just getting started…Obviously, this is my own opinion and I would be remiss in not pointing out I might be totally wrong.
A last quick note, added at the end of my quick edit: In the interest rate markets, there is no greater news factor than the Fed, and as such, Fed generated news (meetings, speeches, official statements, minutes, etc.) often produces sharp market movements…but not necessarily in the way you might expect. In fact, more often than not, my experience is Fed events have often represented the END of a bond market move. To be more precise, I have been WAITING and WISHING for a definitive Fed statement that “We are beginning to taper NOW”, as, once that news (totally anticipated) does hit the markets, I think all those people who are Short Bonds and feel certain they are a “lock” to make money on the downside, are about to find out how this game works. They are all short, but there is nobody left to join them (you need NEW shorts to go lower), and the next thing you see is the market rallying hard in their faces…like 3 to 5 points in 2 or 3 days. No it doesn’t have to happen that way…but I have seen it just like that…more than a few times.
Give me a call if you want to know more,
I will try to cover Stocks (bullish), Corn, Wheat and Soybeans (all bearish) tomorrow.
The author of this piece currently trades for his own account and has financial interest in the following derivative products mentioned within: Treasury Bonds