(06/23/15) Fed Fixation

Interest rates have been volatile, hitting a seven month high. Bond prices fell in reaction to the news of the day, especially regarding Europe and the Federal Reserve, explains Mary Anne and Pamela Aden, editors of The Aden Forecast.

Yes, everyone’s still glued to what the Fed will or will not do. They dissect every innuendo, all in the hope of getting a preview of what the Fed’s going to do next. It is a Fed fixation.

What’s so amazing is that millions of investors and traders actually react to this type of news. This is one important reason why interest rates and bonds have been so volatile.

The economy has become even more important in recent months because the economy has been struggling, pretty much across the board.

Normally, these deflationary pressures would be bullish for bonds. It would fuel a further rise, but it hasn’t been happening. Why?

One reason is Europe. Its economy is looking better. As a result of QE, the EuroZone economy outperformed the US and the UK in the first quarter for the first time since 2011. Plus, its four largest economies (Germany, France, Spain, and Italy) all expanded for the first time in five years.

And even though Europe is showing positive signs, the ECB has said they’ll keep buying bonds for another 15 months. Again, this would usually be bullish for bond prices. It would keep a lid on interest rates.

But so far, volatility continues and US interest rates have gone along for the ride. So have rates in other countries. To some extent, this volatility has been due to tight bond supplies in the open market. And ECB chief Draghi says to expect even more volatility.

So what’s going on? Until we see otherwise, we’ll stick with our view that the Fed will be unable to raise interest rates in the current environment, despite what Janet Yellen says.

Meanwhile, the bond price is still holding near its moving average. This means the major trend is barely hanging on, but it remains up.

The leading indicators for bonds are looking good too. This tells us the bond price will likely soon follow. If so, then interest rates will again head lower.

We’ll soon see, but if interest rates decline soon, as we suspect, it’s going to be uncanny. Why? The current interest rate decline since January 2014 would then be almost exactly the same type of decline as the two previous interest rate declines in both timing and movements.

These happened in 2007-2010 and in 2011-2013. And if these consistencies continue, the upcoming interest rate decline would likely be the final steep drop for the time being. That is, it would be the bond market’s last hurrah for this bull market.

Another interesting point that coincides with this scenario can be seen by looking at the T-Bill short-term interest rate going back to 1967.

The real rate—T-Bill rate minus inflation—has been negative since 2008. And this, combined with practically non-existent inflation and zero interest rates, has provided an ideal backdrop for the bull market in bonds.

Lately, however, the real T-Bill rate has been perking up and it’s now at zero for the first time since 2009. With T-Bills, both nominal and real, at zero, it’s reflecting an ongoing low interest rate environment, which is good for a last hurrah in bond prices.

What should investors watch? This month, interest rates are at an important crossroads. The two most important numbers we’re now watching are 2.30% on the 10-year yield and 3.03% on the 30-year yield.

If these interest rates decline and stay below these levels, then the recent upmove in rates will basically amount to a rebound rise. But if these interest rates stay above these levels, it would signal a tend change is taking place.

That would be confirmed if the 30-year yield rises and stays above 3.60%. And if that happens, we’d advise selling your bonds. For now, watch the markets and maintain caution.

Overall, the Fed is unlikely to raise interest rates in the current environment and rates are poised to head lower. That is, bond prices are set to rise further.

Keep the bonds you have, but don’t buy new positions for the time being. We continue to hold our positions in the ProShares Ultra 20+ Year Treasury Bond (UBT), the iShares Barclays 20+ Year Treasury Bond (TLT), and the iShares Lehman 10-20 Year Treasury Bond (TLH).