U.S. Treasury 10 Year: Interest Rate now above 2.9%

Interest rates have been climbing in recent weeks.  Rates may be reacting to the Federal Reserve Banks recently announced plan to decrease or taper monthly quantitative easing by $10B.  The Fed has been buying an average of $85B per month of US Treasuries and Mortgage Backed Securities during 2013.  The Fed plans to purchase "only" $75B per month going forward.

As a buyer of US Treasuries, the Fed creates additional demand which depresses interest rates.  To say it another way, the US Treasury would have to offer higher interest rates in order to entice more buyers if the Fed were not in the market.  The Fed's purchases are so significant that it currently owns 18.8% of all treasuries http://www.zerohedge.com/news/2013-12-04/feds-impersonation-hunt-brothers-continues

If interest rates continue to climb it will depress economic growth and employment.  Home and auto loans will be more expensive, for example.  And, a larger portion of the US Government's budget will be spent on interest servicing the debt instead of expenditures that grow the economy, such as salaries and fighter jets.  The Fed will likely not allow rates to increase much more for fear of hurting the economy.  Perhaps the Fed has another idea or name for injecting more money in the economy, but effectively taper plans will not be implemented.  Long live the taper.

It is difficult to understand why anyone would buy a US treasury bond if about a third of the issue is being purchased by the Fed.  No way buyers receive a fair price or interest rate while such a large, conflicted, insider is dominating the market.  Presumably buyers simply do not have anything better to do with their money.  They could invest it in equities, or real estate, or art, or classic cars!!  . . . which is exactly why these asset classes have appreciated dramatically over the last 2 years.  Precious metals are another investment option.  Central banks through the bullion banks have actively depressed gold prices to discourage precious metals as an alternative.  

Interest Rates Rising - 10 Year Treasury Hit 2.99%

Interest rates for the 10 year Treasury reached 2.99% yesterday and are now down to about 2.90%.  As I have written about earlier, rising rates crush economic activity.  For example, in housing mortgage rates have increased in parallel with the 10 year Treasury.  Since May national rates for a 30 year mortgage have increased from 3.40% to 4.56%.  http://www.bankrate.com/partners/wsj/#Mortgages

Rate Increase Makes Homes 15% Less Affordable

Annual payments for a $200,000 30 year mortgage at 3.40% are about $10,700.  If the rate is 4.56%, the annual payment increases by 15% to $12,400.  Another way to look at it is that an annual payment of $10,700 pays for a $175,000 mortgage at 4.56% instead of a $200,000 mortgage at 3.40%.  Unless you are paying all cash, home prices just increased about 15%.

And, here is a quick review of how rising rates impact corporate earnings:
http://www.zerohedge.com/news/2013-09-05/10-year-breath-away-300-just-50bps-left-until-disorderly-rotation

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.  http://stream.marketwatch.com/story/markets/SS-4-4/SS-4-35951/

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.  http://www.treasurydirect.gov/govt/reports/pd/feddebt/feddebt_july13.pdf

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.  http://www.federalreserve.gov/Releases/h41/Current/  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.  

US Equities are Over Valued. I am standing by.

The US stock market is over valued.

1) Stock prices relative to earnings are above long-term averages
http://www.zerohedge.com/news/2013-07-29/faith-hope-and-pe-multiple-expansion

2) A historically large portion of the money currently invested in the stock market is borrowed.  Margin debt on the NYSE is near an all time high.  "The exuberant mood comes as margin debt on Wall Street hovers near $377bn, just below its all-time high and well above peaks before the dotcom crash and the Lehman crisis.  By Ambrose Evans-Pritchard, The Telegraph
http://www.telegraph.co.uk/finance/economics/10240740/Investors-euphoric-as-US-margin-debt-reaches-danger-levels.html


3) The US Federal Reserve's POMO operation has been propping up the stock market.  Since January 2009 the US Fed has purchased over $5B of stocks during each of 159 weeks.  Most of the gain in the S&P since January 2009 were during these same weeks.
From Zerohedge, "between January 2009 and April 2013, on days in which the Fed POMO was more than $5 billion, the stock market rose a total of 570 points, on days in which the POMO was less than $5 billion, the cumulative stock market gain was "only" 141 points, and when there was no POMO, the S&P gained... -51 points".
http://www.zerohedge.com/news/2013-08-13/us-treasury-finally-admits-truth-its-all-pomo-and-no-one-dares-fight-fed

The US Fed's POMO operation is confusing because of the jargon and its audacity.  Simply put the US government has been purchasing stocks.  But, how can that be?  I thought the US was in debt?  The US is borrowing more money to finance these stock purchases.  I suspect that these borrowings do not add to the US reported net debt, because stocks are included as an asset that offsets debt when calculating net debt.  If the stocks gain value they would decrease the US net debt.

Other central banks are also investing their governments money in equities.
http://www.zerohedge.com/news/2013-04-25/central-banks-join-herd-openly-buying-stocks-record-amounts

Some day the governments will no longer be able or willing to invest in equities, which will depress the markets.  

The market may not decline just because it is over valued today.  It may even appreciate for several years.  How many years did internet stocks appreciate before crashing in 2000?  It is tough to stay on the sidelines "while everyone else repeats history".  A lot of money can be made joining the irrational exuberance.  And, it can be lost very quickly, so be careful.  

Why the US has enjoyed lower interest rate while printing vast amount of USD

Christopher Marlowe raised a timely issue/question in the comments to one of my recent posts:

why is the rising rate on the 10 year bond unavoidable?  http://www.zerohedge.com/news/2013-08-01/most-important-number-entire-us-economy?page=3
Can't the Fed just buy a bunch of these? Andrew Gause says that the Fed will continue with QE when the interest rates get too high.

This is a very timely question because, as Zerohedge explains, yields on US government debt have recently started to climb.  And, the consequences of higher interest rates are dire.

Zerohedge asserts that if the Fed stops buying US treasuries or even slows their current pace of purchases, which is now commonly called tapering, interest rates will take off.  This is very logical because 1) interest rates started coming down several years ago when the Fed started purchasing treasuries and 2) the Fed is currently purchasing about $85B per month of US treasuries and without this demand yields would be higher in order to entice other buyers to purchase the US government's debt.  

If tapering would increase yields, the inverse must be true and increasing Fed purchases will lower yields.  Thus the Fed can keep a lid on rates by continuing with even more QE and increasing the rate of treasury bill purchases.  Zerohedge, CM, and Andrew Gause are all in agreement.

So why are debts and deficit spending a problem for the US?  Print more dollars to finance solar energy farms and create jobs.  Print more money to save Detroit and other US municipalities.  Print more money to finance wars and military occupations.  Print more money to subsidize big, profitable international agriculture, defense, oil and pharmaceutical corporations.  Keep printing by issuing more treasuries.  The US Fed will keep buying them and interest rates will stay low.  The US has been on this path and will continue on this path until something breaks.  Something will break eventually.  One cannot keep printing and expect a counter party to accept that currency in exchange for real goods, such as oil, food, gold, etc.  When and how will the printing path meet a cliff?

The Zerohedge article presents the quote "Obviously you can't print money forever or no emerging country would have gone broke".  However, the US is not an emerging country and therefore this fact does not help us forecast when and how.  The situation in the US is special because the USD is the world's reserve currency.  Argentina and Japan, to name a couple cannot just print their way to prosperity because no one would accept their currency in exchange for real goods if they printed too much too fast.  The Japanese Yen, for example has lost 25% of its values versus the USD since November when Japan hit the accelerator on their money printing machine.

The US has been able to get away with printing a lot of USD really fast and enjoy lower interest rates because others continue to accept the USD.  Why does Saudi Arabia still accept USD in return for oil?  Or why does China still accept USD in return for iPhones?  They accept USD because they can turn around and purchase jet fighters and oil, and even gold for USD.  There is still trust in the USD and therefore it is called the world's reserve currency.  Additionally, the current global financial system which was set up by the US after World War II is based on the USD.  And, perhaps most importantly there is no practical alternative to the USD.  Would you trust Euros or Yen or SDRs more than the USD?  

Trust fractures.  It does not erode slowly over time.  So it is very difficult to predict when trust in the USD will be lost.  Interest rates are the best early warning system available.  However, since interest rates are being depressed by all the Fed buying it is difficult to distinguish the warning from the manipulation.  So yes CM, the Fed will manage rates down by buying more and more US government debt until they cannot.  Then the system will fracture.

As a side note, one way to get more insight in to the rates on US government debt is to watch the Treasury's auctions.  Zerohedge does a nice job of regularly posting about Treasury auctions: the category of buyers and the bid/cover, for example.  http://www.zerohedge.com/node/476741

And, one more thought: gold could be a practical alternative to the USD or any other fiat currency for that matter.  Gold has served in that capacity many times through history.  The central banks, led by the US Fed have been manipulating gold prices for exactly that reason - to eliminate an alternative to the USD.