Jan 7, 2010
Memo
To: Banks
From: Federal Reserve
Take steps to guard against possible losses from an end to low interest rates by reducing exposure or raising capital if needed.
In the current environment of historically low short-term interest rates, it is important for institutions to have robust processes for measuring and, where necessary, mitigating their exposure to potential increases in interest rates...
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While not the exact verbatim wording used in the Jan 7, 2010 memo, the above attempt at paraphrasing underscores one very big theme that investors must heed as we go into 2010.
That theme is quite simply...2010 is going to be all about interest rates.
A simple look at the yield chart of the 10 Year Note (go to www.stockcharts.com and bring up the chart for $TNX ) tells the tale. If the yield on the 10 year gets above a critical swing pivot of 4% last seen in June 2009, all hell could break loose. Bankers have been fat and happy of late as they have feasted off the steep yield curve laid out before them. Borrow money from the Federal Reserve system at ridiculously low rates at the short end of the curve and then slop that money into the Treasury Note market mid way along the curve for a risk free return. Oh....and then pay yourself a bonus for a job well done...
The January 7th memo to banks sends out a clear warning. The gravy train is coming to an end. Interest rates are poised to rise. And why is the Fed warning of this? Simple.....just take a look at where short term rates stand elsewhere in the world.
Norway: 1.75%
China: 1.36% (and set to rise further)
India: 4.75%
Taiwan: 1.25%
New Zealand: 2.5%
Korea: 2%
Australia: 3.75%
Now take a look at North America.
USA: 0.25%
Canada: 0.25%
Something has got to give soon and the Fed knows it. Hence the carefully worded Jan 7th warning memo. At some point the Fed knows that there will be a re-alignment along the yield curve. Rates will go up, bond face values will drop. Bankers who have loaded up on debt instruments may start experiencing capital losses if rates rise and the bond market takes a drubbing. The Fed knows full well the US cannot expect to continue issuing massive amounts of 7 year, 10 year, 30 year debt at low rates. The regularly held debt auctions are going to start experiencing attendance problems. The bidders are going to start staying away unless they can earn a higher rate on US debt. Higher rates will be demanded because the US economy is not recovering as Obama, Geithner and team thought it would. Job creation is non existent, unemployment is at 10% and if one factors in all those unemployed who have dropped out of the system totally, the unemployment rate is closer to 16% and the amount of manufacturing slack in the system is apalling.
When rates start to shift, look to the commodity sector for action. A rise in interest rates (especially the 10 year Note going above 4%) will signal that future expectations have materially shifted in the USA. This paradigm shift will cause a re-newed excitement into all things hard and physical like metals, grains, energies etc... While other sectors of the market will no doubt suffer as a result and overall indices may correct to the downside, money will be made in "stuff" of real substance. The kind of "stuff" that if dropped on your foot will make you say Ouch !!
I shall be watching the 10 Year Note futures. Once I see that the critical 4% level is about to be breached, I will be looking to short the nearby month. But, more importantly I will be looking to add to my positions in commodity related stocks. I remain bullish on the various uranium stocks I have touted on this site. I also remain bullish on the various coal stocks I have talked about as well as the potash and copper stocks I have noted. I remain bullish on things like cobalt, rare earths, Venezuelan gold stories and Colombian oil stories. It's all good and its about to get better.
Stay tuned.....watch the 10 Year Treasury Note for a breach of the 4% level.
2010 is going to be real interesting...
