QE2 pushing interest rates up and not down
Posted on 09 December 2010 with 1 comment from readers
US mortgage rates have risen by 0.85 per cent since the Federal Reserve first signaled its intension to go for a second round of quantitative easing three months ago. And this week the yield on 10-year US treasuries is up 0.35 per cent to 3.3 per cent in a widespread global sell-off of T-bonds.
This is not supposed to be how QE2 works. The whole point of this $600 billion exercise is to squeeze interest rates down, and keep them down to give the US economy breathing space to recover.
More and more debt
The tax deal this week brought some relief to the stock market which was threatened with a sell-off if taxes went up. But it added $1 trillion of stimulus over two years, reckon BNP Paribas.
Analysts said America’s budget deficit will now stay around 10 per cent for the next two years. Public debt of 110 per cent is close to debt spiral levels – when a country’s debt starts to expand because the interest is not being fully paid.
The US can only hope to get away with this because the dollar is the reserve currency of the world. But the Fed now has to raise around $100 billion in treasury bond sales a month to keep this show on the road.
Buy of last resort
Will the world be happy to buy US bonds for much longer if the value of bonds continues to fall? Nobody wants to buy an asset whose price is falling. And lest we forget how it works, as interest rates go up bond prices go down.
That leaves the Fed itself as the buyer of last resort. But as we now see QE2 does not actually seem to be working as expected. All market forces have inflection points and the Fed may have made a fatal misjudgment.
If so then much higher interest rates will follow very much more quickly than anticipated by 99 per cent of investors. The panic for the exit door will be something to watch and avoid if at all possible. This looks like the end of the road for the bull run in bonds and stocks and another leg down for real estate.
Dollar bulls
The place to be, at least for a period, would be dollar cash or dollar-linked currencies to profit from high interest rates unlike the losing bond holders, and gold and silver would rocket in a flight from bonds as a safe haven, along with other commodities. But this set-up would be unstable too and liable to sharp corrections.
The ArabianMoney newsletter will be taking an in-depth look at how investors should position themselves in this rapidly changing investment environment. You are taking the first step in reading this free analysis but for the full story you need our monthly newsletter (click here to sign up).
1 Comment posted by readers:
I always scroll down amongst DT bloggers looking for your bow-tie, Ed, and then click to your webpage.
I value your continually bullish comments about gold and silver because that’s where I am and have been since January this year. I reckon that I have gained 45% this year on my investment, and I hope to do even better in 2011 if, as you say, gold and silver “rocket”.
Your reference to the instability of gold and silver rocketing is a warning, and I pity those who have gold and silver at home or in their local bank. There will be difficulty getting it back into the market in time not to lose a lot of money.
My belief is that, at the click of a mouse, I can sell all or whatever amount I decide at a moment’s notice in sufficient time to avoid significant loss on a downswing. As a result, I am willing to ride the “rocket” upwards through next year and beyond as long as I keep a daily or even a multi-daily eye on the spot prices.
My investment is with GoldMoney.com which makes all this possible. Why don’t more commentators, like yourself Ed, recommend the internet bullion dealers of Bullion Vault, GoldMoney and others?
Ed Note: We prefer Perth Mint which is 100% state-owned and AAA-rated to un-rated, private organizations but have absolutely nothing else against them.