Interest rates are likely to be one of the factors driving the
equity market this week given the release of FOMC minutes on
Wednesday and the start of the Fed's Jackson Hole Conference on
Market chatter suggests that there is potential for convexity
related selling to develop in the treasury market if the 10 year
treasury breaches the 2.90% area. In layman's terms,
convexity hedging is linked to the reduced pre-payment risk on
mortgage securities and the lengthening of the life of a
mortgage. This activity can push rates up (reduced prepayment
risk) or down (increased pre-payment risk) at certain interest
Forecasting the direction of the treasury market is never
easy, as the desire of foreign central banks to park reserves,
mortgage and corporate hedging activity, and the relative
performance of treasuries to other foreign debt markets can cloud
the impact of inflation and economic growth on yields.
A change in leadership at the Fed is creating uncertainty and
is a reason to sell first and ask questions later. The
media talks about Janet Yellen and Larry Summers as leading
contenders to replace Chairman Bernanke. Yellen is viewed
as favorable toward QE, while Summers is less of a QE
advocate. QE has played a key role in lowering marketable
treasury supply and pressuring yields. It has also pressured
Sentiment toward the treasury market appears negative. A
recent survey by a large brokerage house suggested that only 3%
of participants expected yield to be lower in a year.
Those negative the treasury market may forget that carry is
starting to become interesting given the level of the fed funds
rate and the strong chance the Fed will signal a desire to keep
rates low for a long period.
1) What's your view on the direction for rates into year end -
where will the 10 year finish 2013? 2) Will rates derail
the equity market's rally?
ISHARS-7-10YTB (IEF): ETF Research Reports
SPDR-SP 500 TR (SPY): ETF Research Reports
ISHARS-20+YTB (TLT): ETF Research Reports
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