How the Fed conquered the markets

Can the Fed keep a lid on the markets?

There’s something strangely appealing to me about a symmetrical chart. As an investor, I’m always looking to see what trends can tell me about the future.

Is there method in the madness, and how can I profit?

What follows is probably the most important chart for any investor today – the ten-year US Treasury interest rate.

It’s what investors demand in return for lending the US government their hard-earned cash for a period of ten years.

Why is it so important? Well, essentially, it’s this asset that determines the price of all other assets.

If this chart takes off, then – all other things being equal – just about every other asset will tumble.

So, what can information we glean from this wonderfully symmetrical chart? And should we be concerned about that little inflection you can see right at the end?

The chart below pretty much plots our confidence in the system – that is, how much we investors trust the government. How much do we ask in compensation for lending to these guys?

Up and Down: 60 years of faith in the system

Ten-year Treasuries chart

(Source: St Louis Fed)

Well, as you can see, following World War II – the far left of the chart – belief in the US government was strong. The rate on the ten-year Treasury was as low as it is today. The system was working, and working well.

From this point, it took some 27 years for successive governments to lose all faith. The ’70s were particularly unkind to the USA. Both investors and the public lost confidence in the system and inflation spiralled. As you can see, rates on government bonds went through the roof as a result.

The situation was much the same in the UK. Higher rates led to recession (represented by the grey bars in the chart) and the outlook was grim.


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First came the years of plenty

Then in 1979, Paul Volcker took the reins at the US Fed. Together with Reagan’s government, he set about rebuilding faith in the system. Pursing monetarist policies (a strong currency, the opposite of what we have today), they began to restore confidence in money itself.

No matter what your political opinion, the chart is pretty unequivocal. In the years that followed, investors were increasingly happy to lend to the government, and to do so at an ever-reducing rate.

Again, this downward slope on government yields was similar for much of the West. Triumph in the Cold War, the fall of socialism and growing faith in the capitalist system, all helped to win over investors.

Academics even came out with hypotheses suggesting that lending to the government was risk-free. As such, pension funds and insurers filled their boots. Rates on government bonds went down, governments borrowed with impunity – everyone was happy.

But our time was up – and markets crashed

Well, following decades of falling yields on government bonds, the time finally came. A meltdown in the capital markets wiped trillions off the value of everything.

And as we all know – rather than risk shaking the faith – the central planners went about falsifying the yield curve. They printed more and more money to buy government bonds and force rates to stay low. That was, and is still, their plan.

Many players in the markets fear that the yield curve is about to break out and head north. Tapering talk has already started the process… you see, at the far right of the chart? Yields are rising!

The central planners can’t stop now

But it is my contention that the yield curve cannot be allowed to be set loose. That would surely bring about a meltdown in the system. This is why I maintain my position that tapering is a con. It’s why I write on this topic so regularly here at The Right Side.

Of course, there will be ramifications to all of this money printing. In fact, I suspect that’s what’s spurring on the gold market right now.

Now, let’s look at the chart again. Our central planners are hardly likely to let the last 27 years of hard work go to waste, are they? The last five years have proved that.

Then again, if you think these guys really are about to let go – and many investors do – you should place your bets accordingly. What does that mean? Sell up and sit on cash.

As for me, however, I’m staying put. I’m aboard the planners’ rollercoaster. It’s going to be quite a ride, as these boys fight the markets at every turn, trying to keep that damned yield curve from rising!

But I just don’t believe that after decades of keeping rates low, central planners are going to throw in the towel that easily. So, I’m staying in the stocks game.

This article is taken from our FREE daily investment email The Right Side.
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Information in The Right Side is for general information only and is not intended to be relied upon by individual readers in making (or not making) specific investment decisions. The Right Side is an unregulated product published by Fleet Street Publications Ltd. Fleet Street Publications Ltd is authorised and regulated by the Financial Conduct Authority. FCA No 115234. http://www.fsa.gov.uk/register/home.do

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