Feb 21, 2005

Trading Trends in Interest Rates

These are some technical charts applying my interpretation of Stanley Kroll's trading rules to the current rate environment.

Click on a chart to see a larger image!!

It is hard to look at the 30-yr chart and take away anything but ambiguity after the action of the last couple months. With the FOMC committed to avoiding deflation at all costs and Greenspan telling the world last week that he did not really agree with long-term interest rates I lean towards higher rates and have tried to trade that way. The chart no longer supports that view. We also experienced a very whippy broadening range in Dec. (the two most recent highlight marks) leaving little room to benefit from betting either way. Some have mentioned that mortgage hedgers were buying into the most recent highs (price highs yield lows) so maybe it is their negative convexity positions that account for the number of reversals.

Posted by Hello

The 5-yr chart shows a much more useful pattern with the yield uptrend looking pretty stable. This reinforces my belief that long rates need to head higher. Trading the 5-yr in here is probably the better option because it allows for tighter stops.

If you read this site a lot you can probably tell that I am a bit obsessed with interest rates. I am mostly interested that a big move may be coming in stocks or bonds because the curve flattening has not coincided with equity weakness. My best guess about the near term is that short yields continue higher and long rates eventually turn to follow within the next 2 months. There is still a strong chance that whatever factors drove long yields to these levels will persist in the near term. Inflation numbers like we had on Friday confirm this view and I would not be too surprised if employment reports begin to show a similar trend towards higher costs. In the short run I think higher rates (and some steepening) will be good for stocks as investors may literally flee the declining bond market to get a piece of corporate profits. Both inflation and higher rates should leave investors with the impression that the economy is stronger than most believe and capable of staying strong even through rate hikes. Over the medium to long term (3-6 months?) stocks will probably come under pressure too as higher rates make bonds more attractive and may uncover some liquidity problems at marginal corporate borrowers.

Oil has a pretty good shot of breaking above $50 next week and if it does a trade through $55 will probably happen within days. That action if it occurs will give a lot of clues to how the markets will react to any impending inflation scare.

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