How Smart Investors Are Taking Advantage of Changing Interest Rates
As long-time readers of these pages are aware, for months I have been warning that interest rates will soon begin rising. Well, that time is clearly now—we are seeing a significant shift in interest rates. And that means that this is the time for investors to act.
When I began saying that interest rates were due to rise—because I predicted that the Federal Reserve would begin reducing their asset-purchase program—interest rates on 10-year U.S. Treasuries were less than 1.7%.
Even when interest rates broke through the two-percent level, I wrote my article “Why U.S. Treasuries Are Still the Worst Investment,” which warned readers to move out of fixed-income investments.
That opinion certainly hit home last Friday when the Bureau of Labor Statistics (BLS) released the monthly non-farm employment report. For the month of June, a total of 195,000 new jobs were created. (Source: Bureau of Labor Statistics web site, last accessed July 5, 2013.)
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In addition to a very strong report in June, there were significant revisions for April. The BLS initially reported that only 149,000 jobs were created, but that number was later revised upward by 50,000 for a total of 199,000 new jobs; the May report was revised upward by 20,000 jobs.
While some investors might have had doubts about whether the Federal Reserve would begin to reduce its asset-purchase program, the latest data points should now completely eliminate that idea. As I’ve been writing about for the past few months, the Federal Reserve will, in my opinion, begin reducing its asset-purchase program—and that will have a significant impact on interest rates.
After the release of the strong employment report, 10-year U.S. Treasury notes jumped 18 basis points to yield 2.68%. That means that since the month of May, 10-year interest rates on U.S. Treasury notes have increased by approximately one percent.
That doesn’t sound like a large increase in interest rates, but in percentage terms, it’s very significant. Essentially, the market has already priced in most of the initial phase of the reduction in the asset-purchase program that I believe will begin in September.
The chart for the iShares Barclays 20+ Year Treasury Bond Fund (NYSEArca/TLT) is featured below:
Chart courtesy of www.StockCharts.com
Notice the circled area in the above chart, which shows the significant drop in price of this exchange-traded fund (ETF) that tracks long-term U.S. Treasury bonds. For many investors who aren’t advanced enough to be able to go short in the fixed-income space, had they even moved to cash when I began discussing the potential for higher interest rates amid a change in Federal Reserve policy, they would’ve saved a significant amount of money.
With much of the move by the Federal Reserve priced into the market, interest rates will most likely take a pause and trade in their current range for the next month or two. Once September comes along, and the Federal Reserve, in my opinion, begins reducing its $85.0 billion-per-month asset-purchase program, I think we could see fixed-income assets resume their drop in price and an increase in interest rates.
While the Federal Reserve will keep short-term interest rates low until 2015, the long-term interest rates will continue to rise. Late in 2014, as the market begins anticipating an increase in short-term interest rates by the Federal Reserve, this will again lead to a further push upward for long-term interest rates.
While many people might think the 10-year U.S. Treasury yielding 2.68% is high, I believe we will eventually move back up to a more normal historic level of interest rates at four to five percent for the 10-year note. That will obviously take several years, and investors in interest rates need to incorporate that possibility when making investment decisions. Historically, once the Federal Reserve begins making policy adjustments, they continue to do so for quite some time.
This article How Smart Investors Are Taking Advantage of Changing Interest Rates was originally published at Investment Contrarians