I believe trading 90 day US interest rates higher from the current 50 year lows is one of the best trades on the board.  3 month yields are at 0.18% 11 November 2009 See http://www.bloomberg.com/markets/rates/index.html which is insane given current economic fundamentals and Fed policy. The currency risk holding US dollar denominated debt with a 0.18% is greater in one hour than the annual yield. How I’m going to benefit from rates eventually moving higher while collecting monthly option premium of 2.5% to 5% using zero leverage is explained below. For rates directly from the US Treasury see http://www.ustreas.gov/offices/domestic-finance/debt-management/interest-rate/yield.shtml

 

 

If you have any questions please call or email me using the contact information below.

 

My thoughts on current market conditions

 

Prices of real estate, stocks and all tangible assets will eventually hit new highs

Any deflationary pressures will be temporary. The dollar will devalue, interest rates will rise slowly.

Properly positioned, hedged current fundamentals will create exceptional trading opportunities.

The purpose of my reports are to point out these opportunities and introduce strategy to capture the moves.

 

Technically we’re still in nasty downtrends for most sectors but bottoming, see the opinion column on this page http://sites.barchart.com/pl/cta/ no password required, updated daily. Fundamentally US policy makers and the Federal Reserve are implementing policy to devalue the dollar and squash any potential deflationary pressures. Their objective is to support the values of real estate, stocks and most tangible assets.

 

Fed Governor Kevin Warsh November 6, 2008 http://www.federalreserve.gov/newsevents/speech/warsh20081106a.htm#f9

The Fed responded, introducing lending facilities designed to support liquidity in overnight and short-term funding markets. With the approval of the Congress, Treasury also took significant action, making large capital injections directly into banks to help jump-start the credit intermediation process.

 

Deflation is unacceptable and a “worst case scenario” for the US economy.

Given current US  economic fundamentals inflation is by far the lesser evil.

I believe US policy makers and Federal Reserve are prepared to fight deflation, have a plan in place and have already begun to implement this plan. I believe the new administration has no other choice than embrace this plan; the projected 2009 US budget deficit of 1 trillion USD is confirmation. 

 

I’d like to start with specific quotes pulled from the Federal Reserve’s website specifically a speech Bernanke gave prior to becoming Chairman of the Federal Reserve. In this speech he explains the problem the US is currently facing and outlines specific solutions.

 

Deflation: Making Sure "It" Doesn't Happen Here   click here for the entire speech   

Remarks by Governor Ben S. Bernanke Before the National Economists Club, Washington, D.C.  Deflation: Making Sure "It" Doesn't Happen Here”

 

Quotes from Bernanke’s speech on curing deflation

“Let me start with some general observations about monetary policy at the zero bound, sweeping under the rug for the moment some technical and operational issues”.

“A principal message of my talk today is that a central bank whose accustomed policy rate has been forced down to zero has most definitely not run out of ammunition.”

 

“The Fed would take whatever means necessary to prevent significant deflation in the United States and, moreover, that the U.S. central bank, in cooperation with other parts of the government as needed, has sufficient policy instruments to ensure that any deflation that might occur would be both mild and brief”.

 

“The Federal Reserve stands ready to use the discount window and other tools to protect the financial system, as it did during the 1987 stock market crash and the September 11, 2001, terrorist attacks”.

 

“Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.”

 

“It's worth noting that there have been times when exchange rate policy has been an effective weapon against deflation. A striking example from U.S. history is Franklin Roosevelt's 40 percent devaluation of the dollar against gold in 1933-34, enforced by a program of gold purchases and domestic money creation. The devaluation and the rapid increase in money supply it permitted ended the U.S. deflation remarkably quickly. Indeed, consumer price inflation in the United States, year on year, went from -10.3 percent in 1932 to -5.1 percent in 1933 to 3.4 percent in 1934.¹⁷ The economy grew strongly, and by the way, 1934 was one of the best years of the century for the stock market. If nothing else, the episode illustrates that monetary actions can have powerful effects on the economy, even when the nominal interest rate is at or near zero, as was the case at the time of Roosevelt's devaluation.”

 

What is Money Supply http://en.wikipedia.org/wiki/Money_supply

Why is money supply no longer reported http://www.ny.frb.org/aboutthefed/fedpoint/fed49.html Federal Reserve Bank of New York

What has been the growth of money supply in the US? http://www.federalreserve.gov/releases/h6/hist/h6hist1.txt

Is it increasing? How quickly?, Is Bernanke implementing the deflation fighting procedures he spoke about in his speech?

 

 

I believe the US will follow Bernanke’s blueprint, create more money, devalue the US dollar, creating positive inflation supporting the prices of all assets. Inflation is the only realistic solution to the current economic problems.

 

Inflation  would

 

1)     Reduce the value of the dollar

2)     Make US goods more attractive to foreign buyers while making Foreign goods less attractive to US consumers ( the auto industry in particular would benefit from this )

3)     Reduce the value of the 10.5 trillion in national debt as calculated  in “constant dollars” Much of this debt is fixed in 5,10 and 30 year treasuries and owned by foreign interests

4)     Increase the amount of dollars it takes to buy stocks, real estate and all tangible assets supporting their price

5)     Restore the debt to value ratios for example a home that has currently has a 1m 30 year mortgage which is currently worth 800k would still have the same 1m mortgage but a value of 1.2M, bailing out the owner or bank that owns this property.

6)     Increase wages, the recipients of these wage increases would also have more money to service their fixed long term debt ( everything from mortgages to school loans )

7)     With higher prices/wages generates more tax revenue to service any fixed debt such as 5, 10 and 30 year treasuries.

8)     The end result is less debt in constant dollars, more tax revenue to service this devalued fixed debt producing smaller budget and trade deficits

 

Deflation would

 

1)     Increase the value of the dollar

2)     Make foreign produced goods less expensive and more attractive to US consumers. Domestically produced goods would be less attractive to US consumers sending more money out of the US and generating higher trade deficits.

3)     Increase the value of the 10.5 trillion in national fixed debt as calculated  in “constant dollars”

4)     Decrease the amount of dollars it takes to buy stocks, real estate and all tangible assets lowering their price forcing more sales and entities into bankruptcy.  

5)     Further devalue the ratio of debt to value for example a home that has a 1m 30 year mortgage that is currently worth 800k would still have the same 1m mortgage but would be worth 400K, putting the owner or bank that owns the property in a worse position, creating additional downside pressure on price from forced liquidations.

6)     Decrease all prices of goods and services with decreased prices tax revenue would also decrease

7)     The end result is more debt in constant dollars, less tax revenue to service this increased fixed debt, bigger budget and trade deficits.

 

Inflation should be a welcome alternative to deflation.

For current prices and technical opinions on all major markets see http://sites.barchart.com/pl/cta/ click on opinion.

 

Over the next 12-24 months I’ll be recommending long term position trades starting with 3 month, 2,5,10 and 30 year treasuires outrights, options, and spreads.

 

My first recommendation is betting US 3 month rates higher (from current near 50 year lows). This trade is structured to capture the inevitable increase in 3 month rates while generating income from options writes while rates stay the same and/or gradually increase.

 

90 day interest rates are near historic lows, click this link for today’s rates I’m positioning my clients to bet them higher

Financial Instrument  US 3 month deposit rates click this link for contact specifications and information

How Shorting 3 month US dollar deposits in commercial banks at 98.00, click this link for quotes

While collecting option preimum ( 5% per month on a fully funded position $5,000 per contract) writing slightly out of the money put options, click this link for options quotes

 

Example

1)     Click here for 90 day interest rate quotes on US dollars deposited outside the Treasury system (Rate = 100 – the price, for example 100.00 – 98.00 = 2%) Contract value at 97.92 = $5,200 (deposit = entire value of the contact, assumes zero leverage is used)

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