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   ARTICLE   |   From Scotsman Guide Residential Edition   |   September 2003

Signs of a New Interest Rate Market

Long-term interest rates may have bottomed in June 2003, after setting new historical lows in rates that had not been seen in over 40 years. The 10 Year Note yield, a barometer for the financial community, dropped to 3.07% before bouncing back up over the 3.50% level in a 2 week period. More interesting was the fact that interest rates/yields moved higher immediately after the June Fed Rate cut, targeting the Fed Funds rates to 1.0%, a 1/4 point drop.

This type of market behavior, with long-term rates rising after a Fed cut, has led to trend changes in the past. There has been much confusion in the markets, after this last Fed cut. Not only did the credit market prices fall (rates upward) but also stock prices fell. Some economists are attempting to explain the faltering markets as investor disappointment of the Fed not cutting its Fed Funds by 1/2 pt. History has shown us that the Fed actions are not the catalyst for rates, but rather, the reflection of the current market condition.

Greenspan had proposed his concerns of deflation, which is just opposite to the behavior of the market’s reaction to the Fed’s cut. A drop in stock and credit market prices occurs during inflationary periods. Smart Money (sophisticated investors) could be positioning for future inflation. Despite what we read about lower prices of technical goods, the basic cost of living is extremely high (energy, housing, food services). Also the National Debt is growing due to higher security and military spending, in addition to lower tax revenues. In addition, the weak US Dollar is another obstacle in servicing the National Debt.

The Treasury Department will need to issue more Treasury Instruments, increasing supply to finance the increasing National Debt. Higher interest rates will need to be offered to attract investors and further combat the weak US dollar. Greater supply of treasuries weakens their value, perpetuating higher interest rate pressures.

Technical View


The Interest Rate Complex, composed of Treasuries & Mortgage Backed Securities, had reversed its course prior to the June Fed Cut. Bonds, Notes & Mortgage Backs had entered sell modes and developed head & shoulder formations, indicating a trend change. The Interest Rate Complex’s Internal indicators that measure momentum and strength had been weakening at their contract high prices. Preceding a trend change we often see a divergence of weakening Internal Indicators and new price highs for Bonds, Notes & Mortgage Backs. Negative market characteristic readings occurred in the Interest Rate Complex when prices collapsed with stocks after the June Fed Rate cut, showing a very negative market condition.

Conclusion


History has shown us that when the credit market rates/yields move up opposite to the Fed activity of lowering their rates, we see a trend change to higher rates. Technical indicators align with this high rate behavior.


 


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