Friday, August 16, 2013

Interest Rate Jump is a Crack in the Facade

The interest rate on 10 year US Treasuries is currently trading at 2.85%.  This is a jump from 2.58% just one week ago.  An increase of 27 basis points (bps) may not see like much.  But if you purchased a $100,000 10 year US Treasury bond with a yield of 2.85% instead of 2.58% you would receive about $3,400 more interest payments over the next 10 years.

As of July 2013 the US has $11.9 trillion of debt held by the public and $4.8T held by intra-governmental agencies, such as the Social Security Administration.  The average interest rate on the publicly held debt is 1.9%, which is about $225 billion annually.  This weeks increase in interest rates of 27 basis points would increase the interest on the national debt by about $32 billion for a full year.  The US government cannot balance its budget as it is.  Increasing interest rates make the dream of a balanced budget even more fantastical.

Interest rates typically serve as an early warning system for economic trouble.  Rates serve as the canary in a coal mine.  However, as I wrote in a post about a week ago the canary has been suppressed further than a NSA whistle blower.  Purchases of US debt by the US Federal Reserve Bank have kept rates low.  As of August 14 the US Federal Reserve Bank owns over $1.9T of US Treasuries.  The Fed also has $1.4T of mortgage backed securities that are guaranteed by Fannie Mae, Freddie Mac, and Ginnie Mae.  And, the Fed has a few more assets it bought to help save the financial system and the economy which bring the its total assets to $3.6T.  Certainly, interest rates would have been higher if the Fed had not purchased $1.9M of Treasuries.  

Any chirp from the early warning system must be closely scrutinized since it is coming from behind a thick curtain of suppression.  The Fed will continue to acquire more and more US debt in a do or die effort to keep interest rates low.  At some point the global financial system will not let the US print more and more money by buying its own debt and the scheme will fracture with a sudden snap.  No bending before breaking.  If rates continue to climb next week, it will show that the Fed has become impotent.  Fear will over take greed.  

Keep your powder dry!  When the bond market fractures it will drag equities with it.  Speculators will sell quality stocks in order to raise cash and meet margin calls.  I have cash ready to take advantage of this eventuality.  What else would I do with cash?  Loan it to the US government for 10 years at 2.58%? No way!  One of the best investments I ever made was Coca-Cola (KO).  I purchased KO for about $23/share in 2008 during the market crash and sold it 3 years later for about $33/share.  That is a gain of about 50% in less than 3 years plus about 5% dividend yield during that time.  An impressive gain on a very solid, low risk investment.  

1 comment:

  1. Here is an interesting chart showing where all the money has been going in the last five years:

    Scroll down to "Household Income v Federal Reserve Assets"