"Any time you get a trend reversal in the discount rate, that trend remains in force on average for 14 months," Peabody said. "August represents the first month of a trend reversal.
"Even if Fed Is Idle, Rates Are on the Rise
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The New York Times: Your Money
By GRETCHEN MORGENSON
EW YORK -- To the relief of many investors, members of the
Federal Reserve Board have made clear that they will not be
voting to raise interest rates at their meeting next Tuesday.
So why are yields on U.S. Treasuries rising? The yield on the 30-year
Treasury bond jumped to 6.13 percent on Friday, from 5.97 percent a
week earlier.
The obvious reason for the move was renewed inflation fears brought
about by rising oil and gold prices. Adding to the anxiety was news on
Friday that an index of prices paid by factories rose to its highest level in
more than four years and that manufacturing grew faster in September
than analysts had expected.
But investors who remain certain that bond yields will retreat again should
take note. A pattern of unrelenting selling sweeping through the Treasury
market in recent weeks is not caused by bad economic news alone.
Some of those doing the selling may be foreign investors who see the
decline of the dollar hammering their returns. But Charles Peabody, bank
analyst at Mitchell Securities in New York, says the bond market's
behavior also reflects a broad unwinding of bets placed by investors who
were later caught unware by recent interest-rate increases. Many of these
positions are now going bad; as they are unwound, they push rates
higher.
First was the so-called yen carry trade, in which investors borrowed
funds in Japan at microscopic interest rates and bought Treasuries with
the proceeds. When the yen spiked up, profits turned to losses and the
Treasuries had to be dumped.
Last week's disastrous trade was a variation on this theme -- the gold
carry trade -- in which investors bet that the price of gold will drop. They
borrowed gold from a bank, sold the gold and bought Treasuries, making
perhaps 4 percent on the difference between what they paid to borrow
the gold and what they earned on the securities. With gold prices running
up this week, those trades had to be unwound.
The gold carry trade is nowhere near as big as outright bets made on
rates, known as interest-rate swaps, in which one investor agrees with
another to exchange a fixed rate for a floating rate.
Interest-rate swaps account for more than 80 percent of derivatives held
at American banks. In the second quarter, the notional value of
interest-rate related derivatives at domestic banks stood at $25.7 trillion,
up 28 percent from the corresponding period in 1998. As rates climb
higher, these holdings become worrisome.
At the same time, Peabody believes that we are starting to see the ill
effects of rising rates on the nation's financial institutions. "Because of the
positive reinforcement of declining rates over the last two decades," he
said, "most financial players have increasingly used that trend as a way of
boosting their profits."
Now, the reverse is happening. In recent weeks, three small banks --
Keystone Financial Inc., the Regions Financial Corp. and Flagstar
Bancorp -- have warned of earnings shortfalls owing to higher rates.
Will rates rise further? "Any time you get a trend reversal in the discount
rate, that trend remains in force on average for 14 months," Peabody
said. "August represents the first month of a trend reversal." |
