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It is difficult with inflation running amok and the powers that be in denial to be bullish on bonds.  Long term interest rates will have to go higher on a long term basis.  Fundamentally, we simply are going to have a problem in the future getting anyone interested in U.S. Treasury paper at current rates. 

Past empires were all built on the basis of some niche they held that gave them an advantage over the rest of the world.  That might have been sea power or strategic military technology, etc.  Our strong point has been financial.  We currently control the world’s reserve currency, and we exploit this to the hilt.  The past empires have all lost their advantage at some point.  The U.S. will not escape this fate.  Some financial crisis – indeed, the expansion of our current financial crisis that has of late been put to rest, but is still smoldering - will begin the process of the decline of the empire.

This will not happen overnight; and perhaps with our unusually flexible political system, some rescue will be managed.  Nevertheless, in the short run, there will have to be some painful changes made, and higher interest rates will be a part of that.

Our Rydex trading program is short bonds, and it is enjoying a handsome profit on the position.  I believe that if you are going to hold long term bonds, the only viable strategy is to do that on a trading basis.  Long term bonds on a buy-and-hold basis are a guaranteed loser.  

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Bonds continue under a sell signal in our work; but lately, prices have been all over the board.  Virtually all of the up side is due to money seeking a safe haven from a weakening stock market.  The weakness in equities is being perpetuated by growing sub prime loan problems and the bear market in real estate.  Nevertheless, the true rate of inflation as measured by the CPI using pre-Clinton era math is running at about 7.5% while long bonds are yielding barely 4%.  Investing at yields that are less than inflation is a sure loser.

I have begun writing about my concerns over the safety of the typical money market fund.  The competition is fierce among money markets, and all it will take is one to suffer a default on some sub prime paper or other bad paper which they snuck into their portfolio to hype its yield.  It will take only one fund default that cannot be made good by the fund manager, and you will see a run on money market’s putting the 1930’s run on the banks to shame.

Do be careful where you keep your short term money, as well as long term, fixed income investments.  We are living in perilous times when it comes to debt obligations.

Trade the bond market if you like, but long term, fixed income money as well as short term money should be in Treasury bills, even though the yield is lower.  The safety of your liquidity is paramount.  You can buy T-bills without any commissions or fees, as described in our booklet “Buying Treasuries In The World’s Most Secure Investment Account.”  It is included with your annual subscription.

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The only way to approach the bond market in these turbulent times is technically, and our bond model issued a buy signal on January 2.  Bonds have rallied about 200 basis points since then. 

I am not a long term bond bull.  The Fed has no choice but to inflate their way out of the sub prime and housing mess, and that means long term rates will be much higher down the road.  Nevertheless, there is a difference between the next 18 days and the next 18 months when it comes to bonds.  Short term, they look higher, and we will stick with our long trading positions until our bond model dictates otherwise.

Trade the short term if you like, but long term fixed income money should be in Treasury bills.  You can do that without any commissions or fees, as described in our booklet “Buying Treasuries In The World’s Most Secure Investment Account.”  It is included with your annual subscription.

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Bonds bounced with the volatility in the stock market averages.  As the S&P 500 broke to its November low, the long Treasury surged.  This is a matter of money raised by the selling seeking a safe haven.  Now that the market has found some traction, the money is beginning to find its way back out of bonds and into the stock market again.

The U.S. dollar is going to rally here in order to digest the terrible beating it took since last summer.  I see a temporary recovery, but not the beginning of a new bull market in the long bond.  Central banks are going to increasingly shun dollars and Treasuries in the future, and that means long rates will rise, regardless of what the Fed does on the short end.  The yield curve is still very flat by historical standards, and it will find its upward slope to the right once again.  I think this adjustment will come to the fore in 2008, and you will see long rates at this time next year a good deal higher than they are now.

Trade the bonds if you like.  We offer an excellent bond trading program using the Rydex long and short Treasury bond funds.  However, long term holders will find their buying power eroded by a softer dollar and rising interest rates trimming the value of their bonds.   

I still recommend that a portion of your fixed income money should be in Treasury bills.  You can do that without any commissions or fees, as described in “Buying Treasuries In The World’s Most Secure Investment Account.”  It is included with your annual subscription.

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The stock market seems to have air pockets in it.  It cruises along and then suddenly collapses with vigor.  Typically, when the bottom falls out of stocks in general, all that money generated from the selling seeks a safe haven – bonds.  So far, the October situation has been true to form.  Bonds rallied like a rocket.

This enthusiasm for a safe haven in bonds is only temporarily, though, because this money will be moving elsewhere once the panic abates, heads clear, and stomachs settle.  The key is the U.S. dollar.  It is falling like a rock, and it will continue to do so for the next few years.  It makes no sense to invest in a bond and then get depreciated dollars back down the road. 

I look for the purchasing power of the U.S. dollar to fall at least another 30% over the next five years before it finds any long term footing. That means if you buy a five year bond for $1,000 paying 4.3%, you will only get the equivalent of $700 back in purchasing power.  In the meantime, you will be paid $215 in interest, which will buy less and less over the five years. 

The bonds would be a decent trade, perhaps - you know, buy low and sell high or buy high and sell higher.  The quick will be able to take advantage of this approach; but from an investment standpoint, bonds are as close to a sure loser as you will ever find in the markets.

A good portion of your fixed income money should be in Treasury bills.  You can do that without any commissions or fees, as described in “Buying Treasuries In The World’s Most Secure Investment Account.”  It is included with your annual subscription.

If trading is your style, we do offer subscribers trading guidance on bonds with our Rydex bond trading program.  Currently, the model is out of bonds altogether and in the money market fund with a potential sell in the offing.  Our model will sell bonds and move into the Rydex Inverse Government Long Bond Fund (RYJUX) in the event the December bond futures contract trades at 109-31/32 or lower. 

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Our bond trading model is currently neutral and is sitting in money market funds.  The next sell won’t occur until we see the September bond futures fall to 108-19/32.   So, although we don’t have a current trading position, the model is carrying a slight positive bias still.

There is little doubt that the Fed will loosen the Fed Funds rate this time, which will have more impact on general interest rates than the Discount Rate drop they recently enacted.

The down side is that they are consciously sacrificing the dollar in order to boost the economy.  The last employment figures were downright dismal - and the economy and jobs are all about getting folks elected.  With 2008 stacking up to be a donnybrook politically, I look for Bernanke and the Fed to support the current power structure, which is, of course, responsible for them being at the Fed in the first place.

The dollar will lose value, and commodity prices will rise accordingly.  However, sacrificing the dollar will not make Treasuries look attractive to our foreign friends.  Trade bonds if you like - we offer excellent guidance on that front - but do not put your long term, fixed income money in bonds.

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The stock market’s worst performance during the year is from the first of May through the end of October.  The popular averages seem intent on behaving in typical fashion this year, and bonds will see some benefit from this as investors seek a “safe haven” for the proceeds of their stock sales.  From a trading standpoint, you can take advantage of this if you keep in mind that bonds are fine to trade, but they should not be invested in for the long term.

Our bond trading model exchanged into the Rydex Government Long Bond Advantage Fund (RYGBX) on July 18.  Thus far, this position is doing fine.  Our stops are in place, and I expect to make a few bucks on the trade.

The long term outlook is not rosy, however.  The U.S. dollar is going to continue to lose value as the decade wears on.  Although this is a positive for natural resources and tangible asset values, it is a huge negative for bonds.  Don’t invest in bonds.  Trade them if you like, but putting money in bonds long term is all but a guaranteed loser.    

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Bonds are in trouble.  Don’t invest in long term bonds – of any kind.  I am not even excited about municipals.  It’s not because they are in danger of not paying you back.  You will get your money.  The problem is that the money you get back will buy less and less. 

I see long term interest rates going much higher over the next several years.  It all has to do with the rest of the world - our enemies and friends alike - getting fed up with dollars.  The move to “diversify,” which means to “avoid” dollars, is already under way.  China has expressly announced that they are going to pare down their currency reserves and halt future growth in those reserves.  That means they want to get rid of dollars in deference to other things. 

They will be investing in real assets for the most part - buying raw material producers. They will, of course, be buying technology (military) and political influence.  The result is that one of our best Treasury customers is going elsewhere with the bulk of their money.  In fact, most central banks that hold dollar reserves will be following suit, at least in terms of reducing their dollar holdings.  I believe that all of them will begin accumulating gold now, with China in the forefront.

Furthermore, the dollar is being shunned by oil producers who have finally had enough of this silly game.  They sell us a very valuable, depleting resource in exchange for dollars that we run off on our presses in any quantity we wish.  The list of oil producers demanding euros for oil is growing rapidly.

Dollars and dollar-based assets are going to find it more difficult to find a home from now on, and that means that long term interest rates are going to rise.  It has little to do with the Fed.  They dictate short term interest rates.  The market dictates long term rates, and long term rates are going higher.

What should you do? 

Consider an account at the Treasury through Treasury Direct and invest in T-bills.  As interest rates rise, you will be able to take advantage of the higher rates each time you roll your bills over.  Consider some money in the income stocks recommended on our buy-and-hold list.

Bottomline, leave the bond market to the traders.  Professional Timing Service does offer bond trading recommendations, but serious investment money should not be in long bonds.

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Bonds look like they are going to move much lower over the next few years - and what surprise can that be given the sorry state of the U.S. dollar.  The best that can be said for the U.S. Dollar Index is that after becoming very oversold at the 81.00 level late last month, it bounced to just over 82.00.  That is no big deal, and it will find 82.50 solid overhead resistance.

Bonds have reflected the dollar bounce by staging a very insignificant upside recovery.  That leaves us with a trigger point in bonds at 110.00 basis June futures.  Once it breaks below that, the next stop may not be until bonds fall to 109.00.  That is near term.  The long term outlook for bonds is much worse.

We are going to take up the issue of where to invest for income in our June market letter.  There are better investment avenues to generate income than Treasuries, but Treasuries can be suitable for some ultra conservative situations.  In that line, suffice to say, if you have fixed income money to invest, stick with short term Treasuries.  Our bulletin “Buying Treasuries In The World’s Most Secure Investment Account” explains how you can buy T-bills securely with no commission in amounts of as little as $1,000.

Net-net, leave the bond market to the traders.  Professional Timing Service does offer bond trading recommendations, but serious investment money should not be in long bonds.

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U.S. bonds are going to find it more difficult to find a home as foreign central banks turn to euros, gold, and other commodities rather than stockpiling more dollars.  The Fed is faced with a deteriorating housing market, which will continue to spill over into the consumer sector.  The positive spin on the Street is that “the housing problem will not be that bad because it is a recognized problem.” 

Actually I don’t think it is.  Yes, the problem with sub prime loans and other bad debt is recognized.  What is being ignored is the magnitude of the problem and how long it is apt to last.

Bonds are a bad bet when the dollar is weak, especially as a long term investment.  The Fed could rescue the dollar from its perpetual descent by raising interest rates; but that, in itself, is a problem.  In order to be effective in making the dollar attractive in today’s world, they would have to stop making so many of them, and they would have to raise interest rates well over the true rate of inflation.  Keep in mind that if the CPI were calculated with Clinton era math, it would be about 7%.

Such a move on the Fed’s part would only exacerbate the already unappreciated magnitude of the housing problem.  The Fed - faced with an ever-weakening housing problem, mounting loan defaults, and the threat those pose to economic activity - will opt for another answer.  They will liquefy.

Their job, of course, is not to protect the dollar, but to protect the banks and to retain their unique relationship with the government.  The Fed is a private banking system.  It is not a government agency.  They need the approval of the powers that be to continue the sweet deal they struck with the government back in 1913.

What is most important - votes or the dollar?  You might argue there is a relationship, but there isn’t.  When it comes to the nitty-gritty, jobs keep folks in office.  Politicians fear one thing – a recession with folks going broke and being out of work.  If the dollar has to be sacrificed to accomplish those goals, so be it.

Buy gold, not bonds.  

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The market hit the skids on February 27.  The Dow Industrials were off more than 400 points, and the Nasdaq fell nearly 100 points.  It is typical during such panics that everything gets sold across the board.  As they say, “All ships rise and fall with the tide.”  There is one exception.  When the market makes a rush for liquidity, there is a big surge into U.S. Treasury bonds as a safe haven. 

Our technical bond trading model took profits on the short side and moved long into Treasuries on February 16, and I was able to enjoy the 200-basis point rally on February 27.  However, these are trading considerations, and that is what our bond model is intended to do – time bond trades.

The long term outlook for bonds is not as rosy.  There are plenty of fundamental problems with investing in U.S. bonds.  For example, the December TIC (Treasury International Capital), which measures net foreign capital inflow into the U.S., came in at a mere $15.6 billion.  To support a current account deficit of $875.0 billion and growing, we need to see a net $3.5 billion come in every business day.  Perhaps this has a lot to do with the debacle on February 27^th.

If our foreign friends fail to support our spending habits and stop buying our bonds, the bond market is going to decline with a vengeance. 

We will stay with our long side trade, which is nicely profitable at this point; and we will eagerly await the next sell signal from our bond trading model.  We will keep subscribers on top of that signal, and we will have specific advice as to where to move long bond money.  Bottom line, investors should not hold long bonds unless in a trading account.

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"OPEC Dumps $10.1 Billion of Treasuries As Oil Tumbles" was a recent headline.  This is in line with their desire to “diversify” out of U.S. dollars.  One excuse for their reluctance to stick with their Treasury investment is that this is a result of lower oil prices reducing their income - and thus the amount of money they have available for investment.  This may have some truth to it; but basically, it looks like they feel they own too many dollars.

This puts a damper on a decision to reduce U.S. interest rates as lower rates will provide less incentive to potential bond buyers who are already disenchanted.  My take is that the government will not lower rates any time soon.  The repercussions of such a move are simply too damaging.

The U.S. dollar is going to fall further.  Inflation will be one result, regardless of whether we see a full blown recession caused by further weakness in housing or not.  As the dollar falls, U.S. Treasuries will be harder to sell to reluctant buyers.

From a purely technical viewpoint, my bond trading model is negative.  However, a rally in the March bond future to 112-28/32 or higher will take our trading program long.

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Bonds are rising and long term rates are falling.  This has produced an inverted yield curve where short term interest rates are higher than long term rates.   The inverted yield curve - along with a rising bond market - seems to be forecasting a recession in the economy for 2007. 

Bond traders are expecting the Fed to lower rates in response to a recession.  The Fed will have a bigger problem defending the dollar - especially if they lower interest rates.  They will have to walk a thin line.  They can stand for a weaker dollar as long as the decline can be kept orderly and gradual; but with the world looking to diversify out of the greenback, a mistake could be costly for the dollar.    

As the dollar falls, inflation will rise.  It is difficult to see interest rates falling in an inflationary environment.  If the Fed chooses to “deep six” the dollar with lower interest rates in an inflationary environment, they just might see a dollar panic they cannot stem. 

As the dollar falls, the manufacturing sector will see some benefit and employment in that sector will at least stop declining.  That may be good for some votes in 2008.  However, any benefit will be overshadowed by higher prices, and that includes the price for money.

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Our short term bond work remains positive, although tired.  Nevertheless, we don’t have any new trading signals.  Until we do, our Rydex bond program will hold its long position in the Rydex Government Long Bond Advantage Fund.

This is a difficult time to be a Fed watcher.  They seem to reverse course with every speech, and you can cut through the gibberish with a simple rule.  While long term rates remain below the true rate of inflation, rates will chase inflation and move higher over time.  The current pause is more politically motivated than anything else.  The real rate of inflation is closer to 7% than the official rate of 4%, so I don’t expect either the trend for rates to let up or inflation to increase over time.    

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Our bond model is currently long bonds, but this is a trading model.  As for my longer term outlook, I am still bearish on long term Treasuries.  We are in the 5^th year of a 15 to 20 year period when commodities and other real assets will outperform financial (paper) assets.  I expect to see inflation gain momentum as the decade progresses, but I don’t expect to hear much about that from “official” statistics.  The government has a vested interest in low inflation, and they are the ones that keep the numbers.

Foreign borrowers are not going to totally opt out of U.S. Treasuries in favor of something else, but they will divert more and more of their reserves to other currencies and gold.  In this process, they will reduce demand enough to work interest rates higher over the next several years.

The Fed, of course, controls short term rates rather than long rates, but their decisions and policies make a difference in the long term rate structure.  For example, something that few consider in measuring the Fed’s actions is their somewhat subjective approach to bank examinations.  When their examiners audit member banks, they can be lenient or strict in their assessments.  When the Fed wants to tighten, they have their examiners tighten up their assessment of member bank loan portfolios. 

This has the effect of raising longer term rates like mortgages and commercial loans.  This does not affect longer term Treasuries directly, but it does have an effect on long term rates in general nonetheless.

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Bonds do not seem to be acting as strong as one would expect.  The stock market has been dismal; and often times, there will be a flight to quality - that being U.S. Treasuries.  This hasn’t been the case lately. 

My take is that the world’s central bankers are not interested in plowing any more of their depreciating dollars into U.S. Treasuries. They are not interested in pulling the stilts out from under the bond market and thereby ending up shooting themselves in the foot … but enough is enough.

Consequently, the bond market has been flat while the yield curve has continued to subtly invert.  An inverted yield curve is not good for stocks or for bonds.  In fact, the only market that does well while the yield curve is inverted is commodities because an inverted yield curve is indicative of inflation.

Our advice is to avoid bonds.  Stick with short term Treasuries.  Right now, the six-month bill looks interesting.  Set up your own account at the Treasury at www.publicdebt.treas.gov.  There will be no commissions, and you can manage your own account with low minimums right at the U.S. Treasury.

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Bonds have bounced from oversold levels set late last month, and our Hyperion trading model is long.  However, this is only a trading rally.  It’s not the beginning of a long term decline in interest rates.  On the contrary, interest rates have seen the lowest levels we will see for some time.  Bonds will fall much further as the year wears on.

The Fed is really in a dilemma now.  To stimulate the emerging economic recession, they will have to lower rates.  However, lowering rates will spur the dollar lower and encourage inflationary pressures.  When the time comes, they will sacrifice the dollar.  As the dollar falls, commodities will rise in price in U.S. dollar terms.

I expect to see the Fed raise rates at the June FOMC meeting.  The key is how much.  If they raise rates by 1/2 % rather than the 1/4 % bumps they have been implementing in the past, they may back off for awhile.  Nevertheless, as long as they keep interest rates below the true rate of inflation - which is somewhere between 6% and 8% - the dollar will be weak and inflationary pressures will push commodity prices higher.

The best avenue is to avoid long term bonds.  Invest fixed income money in short term T-bills, and invest long term growth money in commodity driven assets. 

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What can I say?  Bonds look bearish.  The current drop really doesn’t have any significant support until the June contract hits 100.00.  That is another 6% to 7% on the down side. 

I am convinced that the Fed will raise rates further this year, whether or not they skip a change at the June FOMC meeting.  However, they will keep rates low enough to insure a lower dollar.  The trick is to keep the dollar from falling in a panic.  They prefer an orderly lynching - not a panic. 

If the CPI were calculated with the same math as used in the Clinton administration, it would be running between 6% and 7%.  If it were calculated as it was in the 1960’s, it would be even higher.  As long as interest rates are kept below the true rate of inflation and just a bit lower than that offered by other industrial nations, the dollar will slide.

A weaker dollar equates with higher interest rates and a weak bond market.  My advice is to not invest in bonds.  Fixed income money is best kept in short-term instruments like 3-month T-bills. 

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My bond model is, essentially, neutral.  If I were to lean one way or the other, I would be in the bearish camp.  The dollar looks very vulnerable here; and if it begins to fall hard, interest rates will rise.  This is best viewed from a technical standpoint, however, and our work is currently in “stand aside” mode.

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I am a still bond bear, and bonds have been weak.  However, this spate of weakness may be coming to an end soon.  I have announced downside targets for traders following our Hyperion trading model as well as targets for our Rydex bond program, which is currently in the short bond Juno fund.

If the stock market blossoms into a rout this spring, I would expect a good deal of that money to migrate into the bond market.  Although we have price objectives on the down side where we will take profits on our short bonds, we do not have a signal to buy long yet.

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I am a bond bear, but that is not good enough.  My opinions really don’t matter as much as the technical models that I follow.  Currently, those models are long the 30-year U.S. Treasury bond, and that is that.  For the time being, we should be looking for lower long term rates and higher bond prices.

I do believe that the only approach to bonds is to trade them, however.  Investing in bonds is pure folly.  If you have liquidity, stick with 3-month Treasuries.  I think you will be happier with the result.  Incidentally, if you are a T-bill investor, you can set up an account right at the U.S. Treasury.  You can buy U.S. Treasuries with no fees or commissions.  You can invest in all maturity terms as well as I-bonds and TIP’s.  Check it out at:

http://www.publicdebt.treas.gov/sec/secacct.htm

I expect to see the Fed raise rates at least once more in March when the new Fed Chairman Bernanke takes the helm.  Beyond that is anyone’s guess as additional rate increases will depend on future economic numbers.

The implication of lower long term rates and higher short term rates is that the yield curve will, indeed, officially invert some time this year.  An inversion of the yield curve is a “dead on” signal that a recession will unfold within the following 12 months.

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First of all, my bond model is still on a sell, and our position in the Rydex Juno Fund (which is short 30-year Treasuries) is up by 4%.  That is a decent move in bonds.  There should be some support on the down side at 111.00 basis March futures.  If prices can fall below that level, there will be a dynamic drop to 107.00.

Bonds are fine if you are interested in trading them; but as an investment, they should be aggressively avoided.  The 3-month bill will soon be paying abut 4.25% while the 10-year Treasury will be paying only 4.50%.  I can’t see the extra risk for a quarter percent.

The dynamics of this have another aspect.  The yield curve is inverting.  Unless something in the mix changes, short term money will be paying more than long term money.  Such circumstances have always led to recessions in the past.

Our new Fed Chairman is a bit of an unknown at this point, but I think we can count on him to do two things.  One, the Fed will be more secretive about their intentions under his reign.  Greenspan, in contrast, was always good about telegraphing his intentions to the market before he took action.  Second, Bernanke will be fighting the last depression at every corner.  He will opt for inflation rather than recession.  The recession may not respond, but inflation will.

We may well be looking at the lowest long term rates and highest bond prices we will see for years to come.

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Our bond model has been short bonds for some time with very nice profits.  However, I see 110.00 basis December bond futures as providing a decent point of reflection.  We will advise taking profits in our bond program when we get a signal, but I suspect we will see a technical recovery in bonds over the next two months. 

The important aspect to this is that strength in the bond market from now to the end of the year will be a technical adjustment process only.  There is nothing bullish in the long term outlook for the bond market.   

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My Hyperion trading model is short bonds.  Eventually, the long end of the bond market has to wake up to the realities of the short end. There is no doubt in my mind that while Greenspan remains in office, the Fed will continue to raise short rates.

This has been a bit of fun for those investing in T-bills.  Each meeting produces a better return.  If you are invested n T-bills - which is the beat place for liquidity - you should be mindful of the Fed’s meetings.  Be sure your bills are not rolled over just prior to one of the meetings.  If you wait a few days for the next meeting, you will get a better return on your rollover.

As 2005 comes to a close and 2006 unfolds, you are going to see serious inflationary impacts on the economy.  The Fed sees this, and that is why they are raising rates in their “measured” fashion.  Likely, the mistake will end up being that they were not aggressive enough. 

The energy issue is more than a matter of money being too loose.  In reality, inflation is more a matter of being able to produce unlimited supply of dollars and yet being able to extract a limited amount of oil.  Something has to give in that case, and it has been the price of oil and natural gas.

The best place for liquidity is T-bills.  If you have the desire for longer term commitments, buy commodity country bonds.  My favorite is Canada. 

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I have been alerting subscribers in the newsletter to the possibility of a liquidity panic in the markets.  We have entered the absolute worst months in which to make money - September and October.  The worst crashes in the past have started quietly in August, gained momentum in September, and crashed in October.  These are dangerous months, and the possibility of seeing literally several thousand hedge funds in a scramble for cash is not out of the question.

In October 1987, the Dow dropped 25% in a single day.  That is extreme, but it can happen.  Normally, bonds are a safe haven and do well while the market is weak.  However, in the event of a liquidity panic, bonds will not be exempt from the damage.

Where should one keep fixed income investments then?  I recommend 3-month T-bills.  They are paying about 3.5% versus 4.2% from 10-year Treasuries.  I can’t see that the extra .7% is worth the risk, and the yield on your T-bills will follow the Fed’s “measured” rate increases each time you roll them over.

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My Hyperion trading model just sold bonds.  This is a trade of course, but bonds look lower over the near term.

Long term I am changing my tune somewhat.  I have been a bond bear for some time, and although I am not a bond bull, I can see bonds wallowing in a trading range for the next year.  The fundamental problem is that the federal deficit is actually moderating a bit with tax revenues being higher than expected.  This then means that the growth in the amount of government bonds available to purchase is modest.  At the same time the trade deficit continues to soar and that puts an ever-growing amount of U.S. dollars in foreign bank accounts.  They have an interest in buying government bonds with this cash, and since the U.S. bonds pay better than those in the rest of the world, growing demand for U.S. treasuries is outstripping the supply.  The result is that long-term rates are falling and to some extent may continue to do so.

The extent is dependent on the strength of the dollar, and the unsustainable growth in the trade deficit.  At some point, the foreign folks will have had enough of this silly game and look for something else on which to spend their dollars.

This diversification process has already begun in a relatively small way.  China, for example, has been spending a lot of their extra dollars for raw materials and companies that produce raw materials.  Gold will be the next focus of interest on the part of foreigners with large dollar holdings, but U.S. treasuries will still attract enough attention that they will maintain relatively low rates until some surprise event triggers the dollar into a tail spin.  I do believe that will happen, but when is anyone’s guess.  In the meantime, long rates and bonds will offer a trading vehicle to those interesting in that sort of thing, but as in investment will continue to offer sub investment worthy returns and high risk.

Trade them if you will, but investing in is a dangerous way to run in place.  

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Our Hyperion trading model bought the bond futures on April 15, but it took profits (did not short) a bit early - on May 13.  Since then, bonds have moved higher; but somehow, I think the Hyperion model has an appropriate position right now being on the sidelines.

The current account deficit is twice as high in relation to GDP as it was in the mid 80’s.  The dollar fell 30%, and the account deficit came more into line.  The current account deficit is now 6.5% of GDP and could well run to 7.5%.  The dollar has fallen 15% so far, with little effect obviously.  I believe the dollar will remain weak, but it will need help.  The current account deficit will not improve until interest rates rise, and that rise is inevitable.

It is a matter of how measured this rise might end up being.  It could be gradual; but with the deficit this far out of line, the adjustment process may well be violent and a surprise in its timing.  Do not invest in bonds.  Buying bonds at this juncture versus buying 3 month T-bills is not an investment.  It is a gamble, pure and simple.

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Our technical model is currently long the U.S. Treasury bond, but bonds remain a trading affair.  There is no reason for investors to put long term money in bonds.

I expect to see the Fed continue with their measured interest rate increases, and this offers investors in short term governments a nice advantage.  If you open an account at Treasury Direct http://www.publicdebt.treas.gov/sec/secacct.htm, you can easily buy T-bills, even with smaller amounts of money. 

You can elect to have your account automatically rolled over each time the bills come due, which has been giving investors an additional 25 to 50 basis points in yield with each consecutive rollover.  Already, we are looking at short rates at about 3% versus 10-year bonds at about 4.25%. 

I believe the T-bills will certainly end up paying close to the current 10-year bond rate, and they may even end up exceeding long term rates.  When this occurs, it is referred to as an inverted yield curve; and it’s a sure sign of a serious economic recession.

Bottom line, stay out of long term bonds of any kind.  The risk of loss of principal far exceeds the meager rewards in earning 1.25% over safe and flexible T-bills.

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Our bond model is currently on a sell signal, and I expect to see bonds continue lower this year as interest rates rise.  It is likely that we are entering a period much like the 1970’s when we suffered a recession while the price of commodities moved higher.  Energy will have a profound negative impact on the economy this year and this along with a weaker dollar will put immense pressure on interest rates.

The biggest mistake an investor can make today is to chase yield.  Money markets pay little to nothing, 3 month T-bills pay 2.75%, a generous stock dividend is considered to be anything approaching 4%.  The tendency is for investors to ignore very high risks in order to improve returns.  With a few exceptions, Canadian energy trusts for example, anything paying over the 3 month T-bill rate carries risk in direct proportion to the amount they pay over that 2.75% baseline.

There are ways to improve your returns, but buying long bonds that are virtually assured of ending up losers, is not the way.

My advice is to avoid investing in bonds.  You can certainly trade them, and we have programs that address this approach, but invest in them at your financial peril.

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The Fed is persistent in raising rates at a measured pace while long term rates edge ever lower.  This has puzzled the experts, and theories are flying.  The most important thing for investors is to not puzzle over this, but rather follow the directions of solid models designed to keep us on the right path, regardless of experts’ theories.  Reality is what counts.

Our Hyperion model is long the bond.  Even though I am an avowed bond bear, I will stick with the long side.  I will expect lower long term rates until our models tell us otherwise.

However, investors should watch as the yield curve flattens.  If the curve inverts - that is, short term rates rise over declining long term rates - it will be time to take the hint and act accordingly.  If the yield curve inverts, there will be a recession. 

With enormous debt levels and over-consumption engrained in the economy, the next “adjustment” will be a doozy.  Prepared investors will be able to gain.  Those who remain complacent may lose everything.

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The Fed is probably going to abandon their “measured” interest rate increases.  There was some discussion in their last FOMC meeting about the specter of inflation, and I think they will get more aggressive in fighting the inflation threat. 

I know, the government number guys tell us that there is no inflation.  However, the Fed is not the public.  They know better than to simply believe everything that is printed in the press or numbers massaged and generated from the BLS.  I think they see something most of us don’t - worsening inflation.

The bond market involves an array of prices and yields depending on which end of the yield curve you are on.  The Fed directly controls the short end; the market controls the long end.

The long end and the market cannot ignore the short term rates set by the Fed.  However, higher short term rates do not necessarily mean long rates have to rise, at least not immediately.  The effect of the Fed’s rate hikes so far has been to raise short rates from about 1.00% to 2.25%.  Meanwhile, long rates have basically been steady at about 4.80%.  The result is called a flattening of the yield curve.

I expect to see the yield curve continue to flatten as short rates move higher and long rates stay steady … but this is a guess.  The thing for investors to do is this:

First, stay out of long bonds unless you are a trader.  If you buy even a 10-year bond, you are virtually guaranteed to get less buying power back than you put in.  You are going to lose money.

Second, put your liquidity in short term T-bills.  I am going to give our readers a plan in the February newsletter on investing in T-bills and combining this with a commodity investment to produce a very low risk with decent yield package.  At any rate, keep your liquidity in T-bills.  As the Fed raises rates, they will roll over at higher yields each quarter.

Third, watch the yield curve this year.  If the curve inverts – that is to say that short term yields find themselves higher than long term rates – it will be a very bearish sign for stocks and bonds. 

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Bonds have just triggered a sell signal from my Hyperion trading model.  That is fairly clear-cut.  Our work is now short bonds and long the Rydex Juno Fund.  There is no way that we can continue to see a weak dollar and low interest rates, even considering a technical rally in the dollar.

The Fed has clearly signaled their intention that they are not concerned with the weakness in the dollar.  They are on a path to raise rates, although at a “measured” pace.  The December FOMC meeting should produce another 25 basis point rise in Fed funds, which will translate immediately to a 2.25% yield in 3-month T-bills. 

I think that 3% T-bills are a given.  However, a move to 6% during 2005 is not out of the question, nor is a doubling of the long term rate to the 8% or 9% level.  If there is a sudden surprise dislocation in the bond market caused by a lack of foreign interest, these levels could come about sooner rather than later.

Investors should avoid the long bond.  On the other hand, investors stashing liquidity in 3-month T-bills will be quite pleased by this time next year.

The bond market looks terminal, and I look for some serious selling to come into this market once the elections are over.  Our Hyperion trading model is still long bond futures; but if the December T-bond falls to 110-20/32 or lower (basis the December futures), it will take profits on the long position and sell short.  This will be an excellent opportunity to take positions in the Rydex Juno Fund, which is short the bond.   

Bonds have been amazingly strong, and we are holding positions in the Rydex Juno Fund, which is short the 30-year Treasury.  Although that position is clearly early, I still feel that bonds will be falling off between now and the end of the year. 

The most solid key to the beginning of this decline will be found in our Hyperion model and its timing signals on the 30-year Treasury futures.  This trading model is still long bond futures from a price of 107-2/32 basis December futures.  It will sell and sell short if the December bond future falls to 109-7/32.  When that occurs, we will add to our short position by buying more shares in the Rydex Juno Fund.

 Chart courtesy of www.futuresource.com

Bonds remain a trading vehicle only.  You simply cannot afford to make long term investments in bonds.  Interest rates are destined to eventually double today’s levels … at least.

Our Rydex bond program is invested in the Rydex Juno Fund, which is short the long bond.   The daily bond chart is interesting in that it is also showing the second signal setup - like gold and the dollar weekly chart are showing. 

Note that there has been a sell and an intervening buy.  The second sell should be the last nail in the coffin before the bonds tank.  This would be an excellent time to either sell your bonds or buy the Rydex Juno Fund.

 Chart courtesy of www.futuresource.com

Our Hyperion model bought the September futures on June 24, and this trade is going well.  However, our work is now indicating it is time to look for a place to take profits and return to the short side.  Regardless of Fed action or fundamental considerations, the markets will all cycle.  The short term, corrective cycle in the bear market in bonds is coming to an end.  Bonds are going lower for the longer term.

Trade bonds, of course, if that suits you, but do not invest in bonds.

What can I say?  Don’t buy bonds.  They are going lower; and interest rates - especially longer term rates including mortgage rates - are going much higher over the next 24 months.  If you have fixed income money, put it in 90-day T-bills.  You will see your yield increase every time you roll them over.  On the other hand, your friends who stay in bonds will see their principal erode to a fraction of what it is now.

If you want income, invest in T-bills, and then put some money into our recommended Canadian energy trusts.  They pay about 14%, and you will benefit from a falling dollar and rising energy prices.

Bonds have fallen (as we expected); but near term, they are oversold.  I don’t look for a big rally, but further weakness is unlikely until we see a bounce to 111.00 basis the June futures. 

However … make no mistake about the longer term trend in the bond market.  It is down, and interest rates have a long ways to go on the up side over the next two years.

 Chart courtesy of www.futuresource.com

I have to admit, I am somewhat surprised by the persistent rally in the bond market recently.  However, I don’t like to depend on my hunches, and I would rather rely on the guidance of my timing models.  On November 14, 2003 my Hyperion trading model bought bonds when the June futures were 207-27/32.  Bonds have been on the rise ever since. 

What can I say?  If I were to guess, I would likely be proven wrong.  You can see that MACD is close to calling the top in this rally.  The Hyperion timing model holds positions with sizable profits, and we will stay with those positions until the bond model tells us otherwise.  Time is running out for the bond bulls.

Chart courtesy of www.futuresource.com

My futures work is still long the 30-year bond.  There has been an interesting “flight to quality” thing going on over the last few weeks.  However, bonds basis March futures have been having a very difficult time overcoming 113.00 – 114.00 overhead resistance. 

I cannot be a long term bond bull, however; and I feel very strongly that we are looking at the very best interest rate levels we will see for some time.  You can certainly trade bonds successfully, but investing in them at current prices looks like a sure loser.

We recommend trading positions that we established on November 14, 2003 at 108-8/32.  Employ stops at 109-30/32.  I expect we will be raising that stop point in the near future.

 


Charts courtesy of www.futuresource.com

My futures work is long the 30-year bond.  If we are accurate on the stock market, bonds may rally further.  As the pros begin to liquidate (distribute) their stock positions, they will park some of that money in bonds as a safe haven.

The decline in the growth rate in domestic money supply may also help the bond market for a while.  I don’t see bonds challenging their highs established last year, but a little rally here would not be surprising.

Part of the problem with gold short term is a bounce in the value of the U.S. dollar.  That may help bonds.  The dollar simply got oversold and is going to rally a bit.  It will be interesting to see how high it can get before the sellers come out of the woodwork.  I suspect foreign holders of the dollar are anxious to use any strength to liquidate.

Bonds have been struggling to move higher, but my longer term outlook is to see bonds much lower by the end of 2004.  The Fed will likely wait too long to raise short term rates, and that will increase inflationary pressures.  The long bond will reflect these and other dangers by moving lower.  I believe that long term interest rates are about as low as you will see them … for a very long time.

Where are the bonds going next?  They have been languishing between 110.00 and 105.00 for some time now.  Short term, I expect to see bonds rally a bit soon, commensurate with a sell off in stocks.  However, longer term, bonds have a long ways to fall.

In a word, bonds look awful.  There was that nice rally during August and September, but that rally is ending now.  It was a classic bear market rally, recovering right at 50% of the previous decline.  That is usually enough to fire up the bulls’ enthusiasm and set the Street up for the next decline.

We are about to announce new sell parameters for our Rydex bond traders, but we need a few more days and a brief lift in prices first. 

The long term is more important.  Bonds are going to fall much further, and interest rates are going to rise much higher.  You are presently looking at the best levels you will see for interest rates for some time. 

The dollar cannot be divorced from this picture either.  As we discuss in the October letter just published, higher interest rates will not be helping the dollar this time around - or at least not yet.  Bonds and the dollar have a long ways to fall yet. 

Our Hyperion model is still on a sell in bond futures, but our Rydex bond trading program is currently in the money market fund.  I expect a trading buy will develop this month, however.  On a purely technical basis, bonds are looking like they would like to correct the previous decline.  Also, if the stock market does turn down this month as we expect, a lot of that money will move to bonds.

Our work issued sell signals for bonds in late June; and over the last week, bonds have collapsed.  In fact, this may be the largest rout in bonds ever.  The danger now is that hedgers may begin to unwind their “deflation hedges” and “mortgage hedges” established when bonds were moving higher.  If these positions begin to be unwound, the whole selling process can begin to feed on itself as one unwound position begets the next.  

I have been warning readers for months that the bond rally was a trap and that investors in long bonds would end up losing money – lots of money.  I believe we have sent the best of interest rates for many years to come. 

Bonds are enigmatic.  On the one hand, fundamentals point to higher rates.  On the other hand, the Fed has a keep interest in keeping long term rates low.  Hence, we are caught in a tug of war.  Eventually, the fundamentals have to win out, no matter how much the Fed distorts things. 

Eventually, all the debt on the private, corporate and government levels must be reconvened with.  My feeling is that the result will be higher rates, and investors must avoid long term U.S. government obligations.  You can trade the bonds if you like, but buy and hold is definitely not wise.

As the dollar resumes its weakness after the current reaction is over, interest rates will feel additional pressure.  My suggestion is to investigate improving your fixed income yields by investing in foreign currency CDs.

Bonds are booming.  Is the Fed buying?  Bonds had been falling when the market was rising and moving higher when the stock market was falling.  It looked like money was simply moving back and forth.  However, that has changed and bonds are moving higher, along with stocks.  You have to wonder what has changed.

The big question is whether the Fed has been buying bonds.  They have threatened to do just that in order to cap long rates.  With the dollar falling like a rock, you would expect bonds to be falling.  The reason for this anomaly could be that the Fed is making good on their threat; and it has, indeed, been buying bonds.  Nevertheless, this cannot be sustained. 

Our bond work is currently negative; but once the market peaks out, bonds will rally as money once again heads for a safe haven.  Playing bonds on the long side is fine for traders, but investors should have no part of it. 

The inflation numbers have been downright alarming lately, yet investors seem to be in a state of denial.  Maybe they are tired of hearing about yet another worry.  Already they are concerned about mortgage payments, car payments, medical costs, college tuition, and whether the weakening economy will put them out of a job.  Inflation is just another worry, which is easier to ignore than accept.

Nevertheless, inflation is back, and you will be hearing more about it in the press as summer wears on.  Investors should stay away from long bonds and keep liquidity in instruments of two years or less.  Everyone should own some gold.  Our investments in oil and natural gas have been paying handsome dividends - in the neighborhood of 12% to 16%.  It doesn’t get better than that.  

Our Rydex bond program moved into the Juno fund on March 14.&nb