Monday, 14 November 2011

What does FED's zero interest rate for the foreseable future mean ?

Despite that bond yields in Europe are imploding, and Italy becoming the newest member of the elitist 7% club, among countries like Greece, Portugal, Ireland, all seems to be running well in the US wonderland. The cost of borrowing, as measured by US T-bills, has reached the lowest level since the beginning of the financial crisis. The demand of short term bills, namely 3 weeks, which are yielding 0%, and 13 weeks which are yielding 0.005%, is still extremely high as the bid/cover ratio stood at 3.41 in the most recent Treasury Auction.

US yield curve 

The yields on US Treasuries have been relatively stable, after massive efforts coming from the FED to keep long term returns on T-bonds down  through the so-called "Operation Twist". Whether it will work and will lower the cost of long term borrowing, which would have avert the same refinancing and rolling over of maturing debt that got Greece into trouble, remains to be seen. 

Circled line = nominal interest rates, Triangled line = real interest rates

Interesting enough is who is really benefiting from these historically low rates ? It certainly lowers the cost of debt service for people, companies and the US Treasury, and consequently lowers the returns of savings, retirement accounts and money market and bond funds.

Record low borrowing costs are indeed a bonus to the US Government which has been striving to decrease the budget deficit which currently exceeds $1 trillion. The interest expense was $414 billion for the fiscal year 2010 which ended on 30th pf Sept, 2.7% of the GDP. 

According to Bloomberg, during the week which ended on the 8th of November, money market funds returned an average seven-day compounded yield of 0.02%. Record low yields generated shrinking inflows, down to $108.9 billion in 2011, from $207.6 billion last year. 

What about gold ?

Gold is regarded as an investment thriving in an environment of negative real  interest rates (when nominal interest rates do not cover inflation) and high economic risk, and has thus fared pretty well throughout 2011. As FED's chairman Ben Bernanke has expressed no intention of letting nature take its course and let interest rates rise, the current negative real interest rate environment is not going to change in 2012.

Gold is up almost 25% this year, despite two extremely violent drops which occurred in August and September this year, and is looking towards the $2000 level. The $2000 Gold Nov 22 call dominates the market open interest with more than 20,000 lots. Today gold has eked marginally lower towards $1775, but has since bounced back to $1785. I am holding now 70% of my normal Gold position, with the average price of $1749. The stop-loss for half of my position is at $1695.

No comments:

Post a Comment