Spotlight On Interest Rates

Our long-shot prediction at the January Economic Update on Inauguration Day was that a U.S. Treasury auction would fail at some point during the year. Since then, the size of the bailouts has increased, the amount of money being raised by the Treasury has soared, and the prediction has evolved from a long-shot to a market-wide worry.

This week, the market successfully raised $101 billion. We only have another couple of trillion dollars to go before our worries subside. On Thursday and Friday of this week, the bond market rallied once it was clear that the auction hadn’t failed. Worries about the ability of the U.S. to borrow enough money to finance the current round of bailouts and promises are causing the value of the dollar to fall, the price of gold and other commodities to rise, and it is generally forcing interest rates higher. Though the economy needs lower interest rates to jump start consumer spending, I have to agree with Mick Jagger that, “you can’t always get what you waaaant.”

Our mutual fund model has been under-invested in stocks for about 18 months. We still own more (high yield) bonds than is typically the case, and our preferred stocks are more bond-like than stock-like. This week we sold our final remaining money market position to invest in a fund whose returns are based on the long-term Treasury bond.

Unlike a normal bond fund, however, the fund we chose should rise in value on days that interest rates increase. The fund, by “shorting” U.S. government bonds, rises in value when the price of government bonds decrease, which occurs when interest rates go up. Like our gold bet, to some degree it is an investment that will do well particularly if current political and monetary policies run into difficulty. It is not an approach which I enjoy taking. However, I believe that current events will prove it to be a wise allocation of capital in a difficult time.

Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies.

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