PFGBEST Interest Rate Comment

CHICAGO - Nov 17/09 - SNS -- Following is the interest rate futures comment from PFGBEST Research.

FOMC Release and Year-end

Eaven Horter,  ehorter@pfgbest.com or (312) 563-8165

The FOMC comments are again in the spotlight today (215pm EST) and all ears/eyes will be focusing on what change in language may appear throughout the minutes.   Look for my overview of the minutes after the full copy is released but in the meantime, here are three themes to focus on:  

1. Will their language on 'extended' low interest rates stay the same?   My thoughts are yes.
2. Will their language on stimulus related housing stay the same? I believe for the most part it will but I think they will look to more clearly define the exit.
3. Will their language about the rebounding economy change? I believe they will focus on the improved 3^rd quarter expansion.   However, they will also allude to the stimulus programs associated with this growth and discuss the probabilities for the continuation of our rebound ' slow and shaky.

We have come a long way from last Fall/Winter and our economy is continuing to improve.   However, I do not believe we are out of the recession yet and we still have many challenging quarters ahead of us.   Growth, whether less negative or actually positive, is on the horizon and will help alleviate fears.   We as a nation will continue to regroup and come together to move our economy forward but it will be a herky-jerky move up, not a straight path to the upside.

With this being said, don't look for rapid economic expansion or skyrocketing returns in the stock market over the coming months.  Since the Dow hit 10,000, investors have become more wary of the fundamentals of our recovery and are hesitant to put additional monies to work within stocks.   The massive amounts of retail money that has gone into bonds over the past few months and the small rebound in the USD is evidence of this risk aversion and considering we're approaching year end, I wouldn't be surprised to see a trimming of profits to shore up a positive year.

In-line with my previous comments from October, watch for the general markets' continued focus on FOMC language related to stimulus and interest rates as well as a focus by investors on risk aversion.  The USD is still a huge driver of the markets but it is now not only affected by current and future interest rate considerations but also by an increased aversion to risk.   This tug-of-war will create increased volatility within the markets and if economic data falter, look for risk aversion to beat out low-interest rate concerns.  However, if other nations continue to raise their interest rates and the US does not, look for interest rate concerns to win out, with a potential move down to as low as $73 in the US dollar index near the beginning of 2010.

Looking back at the past few weeks, I believe one consideration for the stronger dollar were the prospects for an interest rate hike to occur sooner than later given such strong 3^rd quarter performance; this performance was more stimulus driven and is not sustainable at the pace it occurred.   The earliest prospects for a rate hike would be Q2-2010 but most likely Q3-2010, so the carry trade should still exist for several months.

I do want to draw attention to the growing unified approach the world governments/central banks are taking.   For example, the G20 meetings later this week along with the IMF comments from earlier this week all point to a more organized global approach to tackling the crisis our economies/central banks are experiencing.   This is a VERY positive step in the right direction and I believe it will allow for more appropriately targeted solutions to our individual and global woes: Two thumbs up!   As our nations continue to come together to solve global and not just regional issues, Central Bank comments from nations outside of the US will be in focus even more than the already have been.   In addition to the Australian comments from earlier this week, focus on comments from the European Central Bank and the Bank of England on November 5^th.   I believe these may weigh on investors' hopes for a quick economic recovery.

Looking back to other comments I made in early October related to currency concerns, we are continuing to see international Central Bank action to correct the falling dollar/rising commodity trend.   Look at Australia, who once again raised rates another 25 bps to 3.50% and to India's Central Bank's purchase of 200 tonnes of (gold) bullion to balance their currencies.   This purchase by India brings up an interesting point with gold as we are now no longer just looking at a pure 'the USD is falling and interest rates will rising' concern; we are also looking at a true supply/demand relationship.   This added component to the gold equation will definitely move gold to the upside in the near term as other countries consider snatching up the remaining gold stockpiles from the IMF; let's just hope the scramble doesn't become a sprint.   I think this does point to a bubble in gold prices, especially if we see a 'run' on existing inventories.   However, when the FOMC does raise interest rates next year, look for a correction in gold to occur as gold has been a larger 'risk aversion' play than 'inflation' play.   Over the long run though, I believe you will continue to see diversification out of currencies by international countries into more commodities, such as gold.   Here's an interesting statistic to think about that I saw in a November 3^rd article by Javier Blas on  www.ft.com:

'China's current gold reserves represent only about 1.6% of its total foreign reserves, in spite of its recent purchases from local miners, a vastly smaller percentage than the global average of 10.5%.'

So, let's boil the above down into two scenarios to consider for today:

Scenario 1: The FOMC changes their language and drops 'extended' from their message.     Look for a sell-off in bonds, with 10 year T-Note futures approaching 113 ½ and 10 year T-Note cash yields approaching 3.80%.   This should spark a rally in the USD and a drop in gold; stocks will most likely fall in the near-term but should hold their ground for the most part.

Scenario 2: The FOMC does not change their language on rates.  Look for the 10 year T-Note futures to top out above 119-08 and 10 year T-Note cash yields to approach 3.35%.   This would add a small pop to stocks, a drift down in the USD and an increase in the price of gold; we are already seeing this scenario partially priced into the markets today.

My view is that scenario 2 is most likely.   Look to buy 10 year T-Note futures prior to the FOMC release below 117-24, stop 117-16, then sell above 118-18, then enter new sell position  in 10 year T-Note futures above 119, stop 119-10, hold till at least 117-24. Look to go long gold DEC calls a few strikes above the current trade price or even consider selling DEC puts below a 1060 strike ' focus on locking in a moderate level of profit.

Please call or email me with any questions: Happy trading!

ehorter@pfgbest.com  or (312) 563  -8165

PFGBEST Research Team

Phone: 800-361-6855 or 319-553-2181

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