Don’t Buy Bonds on a Head Fake

01/24/2011 1:11 pm EST

Focus: BONDS

Mary Anne & Pamela Aden

Co-Editors, The Aden Forecast

Interest rates are headed much higher as a result of money printing by the Fed, argue Pamela and Mary Anne Aden of the Aden Forecast.

Interest rates held at their highs this month. Inflationary concerns were the main reason why and that’ll likely keep upward pressure on interest rates.

As you know, the Fed has been pumping money into the system to keep the economy going. So far, so good but it’s come at a very high price.

Under the Fed’s quantitative easing (QE) plans, it bought $1.75 trillion of bonds during QE1. Now QE2 is in force and the Fed has already spent $170 billion, with more coming until unemployment gets better, which could take years.

The bottom line is that Federal Reserve Chairman Ben Bernanke has created three times as much money as all of the other Fed heads combined, which is extremely inflationary.

And since 10,000 people will turn 65 every day for the next 19 years, it’s going to mean ongoing spending and money creation. The bond market knows this and that’s why interest rates are rising.

Investors Steering Clear
Reinforcing this sentiment, foreign investors cut way back on their bond buying according to the latest report, investing not even enough to pay for one day of deficit spending.

Plus, bond mutual funds recently suffered the biggest withdrawals in over two years. This clearly reflects the growing nervousness among bond investors.

For the first time, we’re hearing more talk that hyperinflation will be the final effect of all this massive
money creation. And this would be strongly signaled if the 30-year Treasury yield rises and stays above 4.53%.

This level identifies the mega interest rate trend, a trend that’s been in force for nearly 30 years. Currently, the mega trend is clearly down. That’s because it’s been a time of relatively low inflation.

The bond market is very sensitive to inflation, more than other markets. So looking at the big picture, if this mega trend turns up, it’ll mean rising interest rates for years to come.

It would also mean the bond bubble has finally burst, a big increase in inflation is on the way and perhaps eventually hyperinflation. We believe this is going to happen sooner or later, which is likely why gold has been soaring.

That’s why we do not recommend buying bonds. If the 30-year yield rises and stays above 4.53%, we’d advise even long-term bondholders to get out. Remember, bond prices plunged in the 1970s and it could happen again.

Rates Due for a Pullback
For now, though, the leading indicator for the 10-year yield is temporarily overbought. This tells us that rates have risen far and fast, and they’ll probably resist at the mega trend before they head higher.

That could happen in the months just ahead, but 2011 will probably be the year that marks the beginning of the end of the low interest rate era.

If few investors are buying except the Fed, there’s no other choice. The market will demand higher rates and there won’t be much anyone can do about it.

[The only head fake you shouldn’t buy is the recent blip of a correction in a 30-year bull market in bonds, retorts Gary Shilling. He’s in a distinct minority on that score, however—Editor.]

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