By Chris Gaffney

11/02/10 St. Louis, Missouri – Yesterday was busy here on the desk, with the normal flurry of Monday trading combined with a number of calls to the desk regarding our MarketSafe CD which will be closing out shortly. But the currency markets were fairly quiet ahead of the elections today. But as I pointed out yesterday, trading yesterday was nothing more than the quiet before the storm, as the currency markets were rocked overnight with surprise rate announcements by both Australia and India. I warned you that this week was going to get interesting.

The big news overnight was the Reserve Bank of Australia’s announcement that they would add another quarter point to their benchmark interest rate in order to steer their economy clear of inflationary pressures. The move pushed the Aussie dollar (AUD) to above parity for the first time in nearly 30 years. I pulled a chart of the Aussie dollar which shows that it moved through $1.00 on July 30, 1982 and hasn’t revisited this level since. 1982 was a great year for yours truly, as I was enjoying my last year in high school, listening to Billy Squier and watching MTV. For those of you who don’t believe the Aussie dollar can move above parity, it had traded all the way up to 1.49 back in 1973 (when Chuck was enjoying his senior year in high school!) But we will have to wait a while before we see those kind of levels again as the Aussie dollar couldn’t hold the $1.00 level last night and moved back just below parity as of this morning.

This was the first move by the RBA in 6 months, and caught most economists off guard. RBA Governor Glenn Stevens said the economy has “relatively modest amounts of spare capacity” and citing risk of inflation rising again over the medium term in his statement following the rate increase. Australia’s economy has been enjoying what looks like a very sustainable level of growth with unemployment at just 5.1% and inflation running at a modest 2.8%. But pressure on commodity prices has the RBA worried about inflation risks, and prompted RBA Governor Stevens to take action. This is one reason the Aussie dollar has been such a long-time favorite of the desk; the RBA has done a fantastic job of being proactive, and steering their economy through the global downturn.

The move by Australia also helped their sister currency, the New Zealand dollar (NZD), which moved solidly above 0.77 cents. The kiwi was also helped by a report which showed wages in New Zealand increased which could force a move on the part of New Zealand’s central bank. The kiwi may be a good alternative for those investors who feel they already have too much of their portfolio invested in the Aussie dollar. Both countries look to continue raising their rates, and commodity prices should stay strong with the growth in the Asian region.

Shortly after Australia announced their interest rate move, India joined in with a similar 0.25% move. India’s move was squarely aimed at reducing what is the fastest inflation rate among developed nations. Consumer prices rose just under 10% in India during the month of September. Reserve Bank of India Governor Duvvuri Subbarao said he expects inflation to slow to just 5.5% during the first quarter of 2011 and the economy to expand 8.5%. But he also sounded a word of caution to currency speculators, throwing cold water on any expectations of further rate tightening in the immediate future. The Indian rupee (INR) has gained just 4.8% versus the US dollar in 2010, versus an 11.52% jump by the Aussie dollar. Part of the reason for the lagging performance of the rupee is that interest rates in India remain well below those offered in Australia and Brazil. But growth rates in India, and the sheer size of their economy has many investors comparing it to China instead of Brazil or Australia. And when you make the comparison between China and India, interest rates in India do look attractive.

The moves by Australia and India highlight something that I touched on yesterday: the global economy is on two very distinct paths right now. Countries in Asia are back on a growth path (many never left it!!) and have clearly entered a tightening mode in order to prevent inflation from growing out of control. The economies of the US, Japan, and parts of Europe are still languishing in a no-growth mode with policymakers looking to start another round of stimulus efforts. So where would you rather put your money: in economies that are growing and where you can get higher interest rates; or in economies that are stagnant with interest rates near zero. It is a pretty easy question to answer, isn’t it? This obvious answer is what is propelling the higher yielding currencies of Australia, New Zealand, India, and Brazil up versus the US dollar and euro (EUR).

But the rush into these currencies is a bit worrisome, as “hot money” is never stable and is starting to inflate what could eventually turn into a bubble. Nouriel Roubini, the NY University professor who correctly predicted the housing crash, highlighted this growing bubble in a conference early today. Roubini said, “Prices may be running ahead of economic fundamentals” but also said the “party” can go on for a while. Interest rate differentials will continue to flood these markets with cash, and their central banks will need to try and keep their currencies from appreciating too quickly. One way these central banks can try to control the currency is by building up reserves, which can be used in currency interventions, and as I pointed out yesterday, India has done just that. But Chuck has always warned that currency intervention only works in the short-term, and even countries with some of the largest reserve pools (Japan) have trouble fighting the currency markets. While I appreciate where Roubini is coming from, I agree that the party can go on for a while, and we might as well participate (I’ve never been one to miss a good party!!)

Back here in the US we have finally arrived at Election Day. Hopefully everyone will take the time to get out and vote. I know I am planning to stop by the polling place on my way home. I may have led many to believe I wouldn’t be voting with my statement yesterday when I said that it really doesn’t matter who has the helm of a rudderless ship; but I feel it is my civic duty to vote, and hope that everyone else gets out to vote also. While I do believe the debt that has accumulated over the past several years is pushing the US economy in a scary direction, which will not be avoidable, I still want folks in congress who will at least recognize that we have accumulated this debt and need to do something about it!! You have to start attacking this debt much like you eat an elephant, one bite at a time. And I would like to see members of our congress push up to the table.

But the elections are still not taking center stage in the markets here in the US. That ground is being held by the FOMC, which is set to announce the size of its new stimulus effort tomorrow afternoon. There is not really any question over whether or not they are going to announce the stimulus measures, but the questions are now just how large the stimulus will be. Most believe they will announce $500 billion of new bond purchases spread out over the next few months, but many (including Chuck) believe the actual amount will be much larger. The currency markets have “baked in” a 500B figure, so if the stimulus is anything less, we could see a rally in the US dollar. If they come clean and announce a number that is closer to what I think it will eventually turn out to be, the dollar will be sent to the woodshed. After all, if the FOMC is flooding the markets with US dollars, the value of every dollar has got to go down (according to the laws of supply/demand).

I would expect the Fed to take a cautious approach with QE2 and just announce a $500 billion package, knowing that they will likely have to come back and announce a further package sometime later. And who knows, if the dollar continues to drop (as I believe it will) our exports may actually turn the economy back around and start to pull us out of this malaise. But that theory would stand a much better chance if we still made things in the US! I think the process will be longer, as we will need innovation and the creation of new products and new markets overseas to really increase our exports enough to make a difference.

Hong Kong’s Monetary Authority was recently granted authority to invest in bonds and stocks on the Chinese mainland, giving them the ability to further diversify their currency holdings. The Hong Kong dollar (HKD) has been pegged to the US dollar for a number of years, and recent moves indicate that this peg may be scrapped in favor of a link to China’s currency. Chuck mentioned this possibility earlier this year, and many investors have been purchasing Hong Kong dollars as a surrogate to investing in the renminbi (CNY). Hong Kong’s financial markets are more advanced than those on the mainland, and there is definitely a possibility that China will decide to let the Hong Kong dollar float prior to releasing the peg on the renminbi. With a peg to the US dollar, Hong Kong’s monetary policies are tied to the US, but their economy is more closely aligned with China. We have seen a tremendous jump in the cost of forward contracts in the Chinese currency, indicating the markets believe the Chinese will take further steps to loosen their grip on the renminbi. A first step could be to let the Hong Kong float.

The metals are largely unchanged from yesterday, but they could be impacted by the election returns here in the US. The metals are seen as “safe haven” buys, and the questions surrounding the elections and the size of the FOMC stimulus efforts could definitely produce some volatility in the metals markets.

To recap, both India and Australia raised rates, starting off what will be several rate announcements in the coming days. US elections will take place today, with a change in the ownership of the house predicted. FOMC will be announcing their rate decision (most likely no move) and the size of the QEII. And finally, China may be looking to let the Hong Kong dollar float prior to releasing their tight grip on the value of the Chinese renminbi.

Chris Gaffney
for The Daily Reckoning

http://moneymorning.com/2010/09/20/budget-deficit-2/

As many U.S. citizens continue to rail against the ballooning budget deficit, the reality is that most Americans are unwilling to swallow the bitter pill it will take to tame it.

Perhaps that’s because nearly half of all Americans live in a household in which someone receives government benefits, more than at any time in history, according to a report from The Wall Street Journal.

At the same time, the number of American households not paying federal income taxes has grown to an estimated 45% in 2010, up from 39% five years ago, according to the Tax Policy Center, a nonpartisan research organization.

More than half of U.S. workers don’t earn enough to be taxed. A large segment game the system by taking enough credits and deductions to eliminate all tax obligations. Even though most of us still pay Medicare and Social Security payroll taxes, 13% of all U.S. households pay neither federal income nor payroll taxes.

“We have a very large share of the American population that is getting checks from the government, and an increasingly smaller portion of the population that’s paying for it.” Keith Hennessey, an economic adviser to President George W. Bush and now a fellow at the conservative Hoover Institution told The Journal.

Number Taking Benefits Increases

The government initiated the first entitlement program in 1935 when Congress passed the Social Security Act, creating the retirement program as well as unemployment compensation as part of Franklin Delano Roosevelt’s New Deal.

That was followed by the GI Bill and later Lyndon Johnson’s Great Society ushered in Medicare and Medicaid. In the 1970s, Supplemental Security Income was created on top of routine Social Security benefits for the poorest of the elderly, and so-called Section 8 vouchers began subsidizing rental housing.

Other government entitlements include the earned income tax credit, food stamps, and free lunch programs for poor children.

Consequently, the number of Americans who live in households where at least one individual depends on a government safety net is expanding rapidly.

As recently as the early 1980s, about 30% of Americans lived in households in which an individual was receiving Social Security, subsidized housing, jobless benefits or other government-provided benefits. By the third quarter of 2008, 44% of the public lived in such homes.

And that number has undoubtedly increased as the recession has hammered jobs and household incomes. Some 41.3 million people were on food stamps as of June 2010 up 45% from June 2008.

With unemployment high and federal jobless benefits now available for up to 99 weeks, 9.7 million unemployed workers were receiving checks in late August 2010, more than twice as many as the 4.2 million in August 2008.

The baby-boom generation, those born between 1946 and 1964, will continue to add to the ranks of Americans receiving government benefits. Today, an estimated 47.4 million people are enrolled in Medicare, up 38% from 1990. By 2030, the number is projected to be 80.4 million.

Entitlements Balloon Federal Deficit

The cost of these programs is quickly adding up.

Payments to individuals – a budget category that includes all federal benefit programs plus retirement benefits for federal workers – will cost $2.4 trillion this year, up 79%, from a decade earlier adjusted for inflation, The Journal reported. That’s over 64% of all federal outlays, the highest on record for the 70 years the government has been tracking it. The figure was 46.7% in 1990 and 26.2% in 1960.

All this entitlement spending has punched a hole in the government budget and ballooned the federal deficit to dizzying heights.

The depth of the budget problem was underscored last week, when the Treasury reported that the government ran a $1.26 trillion deficit for the first 11 months of the fiscal year, on pace to be the second-biggest on record.

And the future looks even worse. For the period from 2011 to 2020, the Congressional Budget Office (CBO) forecasts a budget deficit of $6.047 trillion, while the Obama administration projects a shortfall of $8.532 trillion.

The lowest projected deficit in the next decade is a $706 billion shortfall forecast for the fiscal year that ends in September 2014. That doesn’t sound too bad in the context of the 2009-2011 figures, but it’s almost $300 billion larger than the highest federal-budget deficit in human history before 2009.

And even that number is misleading. The federal government’s Generally Accepted Accounting Principles (GAAP) financial statements show the actual annual fiscal deficit careening wildly out of control.

Including the annual changes in the present value of off-the-books liabilities, including Social Security and Medicare, the annual 2008 deficit was $5.1 trillion dollars. The 2009 actual shortfall likely was around $8.8 trillion, instead of the official cash-based $1.417 trillion, according to Shadowstats.com.

Despite occasional bouts of belt-tightening in Washington and bursts of discussion about restraining big government, the trend toward more Americans receiving government benefits of one sort or another has continued for more than 70 years-and shows no sign of abating.

Medicare and Social Security – The Untouchable “Third Rails”

An ingredient in any credible deficit-reduction program would require cutting spending on Medicare and Social Security — by far the costliest and most perplexing of entitlement programs.

Frequently called “the third rail of American politics” – touch it and you die – social security reform is an issue that prompts heated debates among its supporters and detractors. Although Social Security has been changed a number of times since its inception in 1935, nothing has kept the cost from continuing to creep upwards.

This year, the system will pay out more in benefits than it receives in payroll taxes, an important threshold it was not expected to cross until at least 2016, according to the CBO. According to the Social Security Board of Trustees, by 2037 the program’s trust funds will be depleted.

Some say that means the problem is still years away. But others think the real problem is now, since the government — already heavily in debt — will have to borrow more money starting this decade to pay back the Social Security trust fund unless it cuts spending and raises taxes.

Solutions range from decreasing benefits to raising the retirement age, to increasing the payroll tax.

But while there’s a long list of answers, the political will to implement them has been missing.

“Everyone knows what needs to be done, but no one wants to do it, ” Robert Bixby, director of the Concord Coalition, a nonpartisan, grassroots deficit watchdog group told CNNMoney.com.

Meanwhile, the White House has promised America’s new health reform law will generate $575 billion in Medicare cost savings over the next decade, allowing the program to survive until 2029.

But part of those savings will come from reduced “overpayments” to Medicare Advantage, a system that allows Medicare recipients to receive benefits via private health insurance providers. The savings associated with Medicare Advantage efficiencies is expected to rise to $145 billion by 2019.

But this change could prove extremely costly to retirees because most seniors on Medicare Advantage don’t have so-called Medigap policies, which pay the “gaps” in traditional Medicare coverage such as hospital deductibles and doctor co-payments.

The change will force many seniors to switch from Medicare Advantage to traditional Medicare where “they will pay much higher premiums than they ever imagined possible for Medigap insurance” according to Joseph Antos, a health care scholar at the American Enterprise Institute.

The new law also imposes about a half-percentage-point cut every year in the increases in Medicare payment rates for hospitals and other institutional providers. Over time, the compounding effect of the cuts will be so large that 15% of the nation’s hospitals would have to stop seeing Medicare patients Antos told Daily Finance.

One Congressman’s Plan for Change

Cutting federal benefits while the economy is still weak would be a mistake, some analysts say, because it could hinder recovery by giving consumers less money to spend.

But the crushing effect of entitlement programs on the federal budget means they need to be fundamentally redesigned, according to U.S. Rep. Paul Ryan, R-WI.

His proposed bill, “Roadmap for America’s Future,” calls for reducing the federal deficit and debt by partly privatizing and trimming Social Security and Medicare, freezing most government programs and instituting a simplified, two-tier tax system that would cut taxes for the rich.

Ryan proposes to freeze nondefense discretionary spending–15% of the budget–for ten years. His tax plan would eliminate itemized deductions and set rates at 10% for the first $50,000 of income on an individual return and 25% for income above that and replace the corporate income tax with an 8.5% business consumption tax.

He would wipe out ObamaCare and replace it with a voucher-based system in which adults get a $2,300 refundable tax credit to pay for health care. Similarly, Medicare recipients under 55 today would, on retirement, get vouchers to buy private insurance. He would raise the eligibility age for both Social Security and Medicare to 69 and 70, respectively, by the end of this century.

“People see that this debt crisis is real and right in front of us,” says Ryan. They’re paying attention to him, he adds, “because, unfortunately, I’m the only person who’s put a plan out there.”

Only 14 GOP members in Congress have endorsed the plan. In other words, it has no chance of becoming law in its present form.

“My goal was to get other plans launched, to ignite and start a debate,” Ryan says.

The congressman blames the inability to put his ideas in motion on “the crowd that runs Washington now.” But if Republicans win convincingly in November’s congressional elections, Ryan’s strategy will be to win over moderate Democrats and, if the GOP takes control of the House, to force change.

“I see dozens of reinforcements coming in the fall to help us take this fiscal situation seriously so we can get this thing fixed,” he told Forbes.

News & Related Story Links:

• Wall Street Journal:

  Obstacle to Deficit Cutting: A Nation on Entitlements

• ShadowStats.com:

  Hyperinflation Special Report

• Forbes:

  Is It Time to Listen to Rep. Paul Ryan’s Economic Prescription?

• New York Times:

  Social Security to See Payout Exceed Pay-In This Year

• CNNMoney.com:

  Fixing Social Security: The ‘low hanging fruit’

• Daily Finance:

  Medicare Reform Means Some Seniors Face Benefit Cuts

• Money Morning:

  In the Race for a U.S. Economic Rebound, Growing Debt and Budget Deficits Remain the Biggest Possible Roadblock

Easing Eurozone tensions push bond yields higher

Wednesday, March 10, 2010

Former Italian Prime Minister and no stranger to yawning fiscal deficits, Romano Prodi said earlier today that the Greek crisis is over. Having weathered the storm and with less time pressing their own fiscal agenda, the former President of the European Commission said that other lesser indebted Eurozone nations will be spared the Greek-style drama. Signor Prodi sees no reason for other Eurozone members to falter from this point.

European short futures – While it took the euro some time to find its legs in the wake of his comments, credit default swap prices took a nosedive and peripheral debt spreads against core German bunds narrowed.

Although June German bund prices reached an intraday low at 122.68 shortly after U.S. equity markets officially opened, peripheral nations’ bond prices are seeing limited losses. The premium investors paid to hold Greek 10-year debt narrowed relative to bunds, declining by 11 basis points to 280 basis points. During the crisis the spread blew out to 280 basis points. Portuguese debt, subject to resurfacing downgrade speculation this week narrowed to 114 basis points while Italian and Spanish debt also saw premiums narrow to 94 and 91 basis points respectively.

German debt prices rose earlier in the day after weaker trade data at the turn of the year from the largest member of the Eurozone. A contraction of 6.3% in exports eroded the deficit to €8 billion. Euribor futures are a shade lower on the day despite the ongoing provision of abundant short-term liquidity.

Eurodollar futures –Soothing words yesterday from a New York Fed markets official spurred gains in Eurodollar futures. But the gains are giving way marginally today despite further encouraging words from Chicago Fed President Charles Evans. He stated that rates would be kept low in his opinion for at least three or four more meetings. Perhaps his words are less soothing in so far as they put monetary tightening back on the 2010 agenda. The curve is steepening a little this morning with 10-year yields higher by 3 pips at 3.73% and the two-year yield up two pips at 0.89%.

Canada’s 90-day BA’s – June government bond futures slipped 17 ticks to 117.85 sending yields higher by three pips to 3.53%. Bill futures price dropped harder than Eurodollars sending yields higher by four basis points across the curve.

British interest rate futures – Further evidence of uncertainty in the U.K. arrived in the shape of the first decline in five months for manufacturing output. That drop in the data was unexpected but confirmed weakness in demand across the continental economy. Short sterling futures rallied by about four ticks on the news while the June gilt contract slipped by 14 ticks to 114.32.

Australian rate futures – A surge in Chinese export data for February confirmed strong Pacific and Asian activity just as the Reserve Bank’s assistant Governor was priming the nation for above average growth for the next several years. Ahead of tomorrow’s employment report expected to show employers added 15,000 new jobs, money traders sold bill futures propelling yields higher by as much as 10 basis points. Two year bonds added five basis points to stand at 4.76% while 10-year notes maintained a yield of 5.53%.

Japan – JGB futures rose on the weakness in capital spending delivered in a 3.7% decline in machinery orders data. June JGP futures added 12 ticks to 139.42 where the yield slipped to 1.29%.

Andrew Wilkinson

Senior Market Analyst                                                               ibanalyst@interactivebrokers.com

Note: The material presented in this commentary is provided for informational purposes only and is based upon information that is considered to be reliable. However, neither Interactive Brokers LLC nor its affiliates warrant its completeness, accuracy or adequacy and it should not be relied upon as such. Neither IB nor its affiliates are responsible for any errors or omissions or for results obtained from the use of this information. Past performance is not necessarily indicative of future results.

This material is not intended as an offer or solicitation for the purchase or sale of any security or other financial instrument. Securities or other financial instruments mentioned in this material are not suitable for all investors. Any opinions expressed herein are given in good faith, are subject to change without notice, and are only correct as of the stated date of their issue. The information contained herein does not constitute advice on the tax consequences of making any particular investment decision. This material does not take into account your particular investment objectives, financial situations or needs and is not intended as a recommendation to you of any particular securities, financial instruments or strategies. Before investing, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

Andrew Wilkinson

Director of Media Communications

Interactive Brokers Group LLC

8 Greenwich Office Park, Greenwich, CT 06831

(203) 618 8085

Sterling under more pressure

Tuesday,  March 9, 2010

Ongoing speculation that profits earned overseas by Japanese companies is finding its way home before the fiscal year-end is lifting the yen on Tuesday. At the same time Asian stocks are commemorating the one-year anniversary of the lowest closing point of the bear market for stocks with a down day, also providing a knee-jerk bid to the Japanese yen. Other Pacific region data suggests, however, that risk appetite is likely to remain on the agenda and may provide the Australians with another reason to lift rates. But the main story today surrounds the British pound where the bad news just keeps piling up.

Click on link for updated table throughout the day at http://www.interactivebrokers.com/en/general/education/FX-View.php?ib_entity=llc

British pound – Comments from two ratings agencies helped keep the pressure on the pound today while warmer words from one of the MPC members helped stem some of the pessimism. Kate Barker addressing an NIESR audience said that recent data provided grounds for optimism that the British recovery was “broadly on track” and pointed to the gradual disappearance of several of the negative factors holding back the recovery. While admitting that the economy still looks fragile Ms. Barker noted that the downside risks to growth had diminished leaving a still bumpy road ahead.

Speaking on a day when data proved a further weakening of the U.K. trade deficit for January on account of lower chemical and commodity sales, Ms. Barker said that the British economy was failing to feel the potential impetus from weaker sterling. She noted that the British economy was faring no better than either German or French manufacturers presented with the onset of recovery. Her fear is for significant ongoing weakness in Britain’s trading partners that would prevent any benefit from a cheaper pound.

Meanwhile the pound fell against the dollar to $1.4971 and above last week’s 10-month low after Fitch Ratings agency advised that the government needs to accelerate its plans to reduce the budget deficit. Reflecting momentarily on that prospect, investors quickly connected the dots to see that a rudderless government is the most likely outcome in the forthcoming election, further hampering sterling.

Moody’s Investor Services separately cautioned that as the tide of government support for the U.K. banking system slowly ebbs out, it will leave exposed those financial services companies that have failed to improve their funding position. The reports together were taken negatively by sterling today which also fell to 90.61 pence against the euro.

Euro – Having risen to $1.3700 on Monday the euro is back on the defensive today and retreated to an intraday low at $1.3550. Most recently the single European currency traded at $1.3558. It also shed ¥1.3 to stand at ¥121.73. Friday’s low against the dollar was at $1.3530 and only if the euro can hold above here will it start to look constructive.

U.S. Dollar – A Manpower Inc. survey suggests that the recovery in employment is expanding into the second quarter, while jobs growth across emerging markets is also likely to continue its expansion. The world’s second-largest temporary employment agency said that of 18,000 surveyed companies, 76% leave hiring intentions unchanged between April and June while 16% said they’d expand the number of workers. The most optimistic response came from companies located in the North East. Within emerging markets it’s no surprise to learn that hiring intentions were strongest within nations such as Brazil and India, while they were the weakest in Italy, Spain and Ireland. Some analysts claim that without the adverse impact of winter snowstorms, the February reading of U.S. employment would have shown jobs added. Previous data during disrupted winters have shown sharp rebounds in job additions during March. The ongoing U.S. economic recovery is bolstering the dollar under current conditions.

Japanese yen – We’ll just have to wait and see how far the yen rises in response to the seasonal impact of repatriation. With global equity markets around 60% higher than this day a year ago, the world is in far fitter shape and the recovery remains encouraging. And so the premise that the yen is rising on a risk aversion theme has to go down as a somewhat bogus claim today. We await any word from the Bank of Japan, which is supposedly mulling ideas on how to breathe life into the Japanese economy. The impact of further quantitative easing via additional government bond pressures should serve to weaken the yen, which currently stands at ¥89.75 against the dollar.

Aussie dollar – A buoyant ANZ job survey for February made the previous month’s downturn appear to be little more than an aberration. The measure of newspaper advertisements and Internet job listings increased 19.1% – the largest jump in the reading since it was first compiled in 1999. The data comes days ahead of the February employment report, which might prove so strong that it will prevent the RBA from taking a breather after its February interest rate hike to 4.00%. The Aussie unit jumped in the immediate aftermath of the data and reached 91.17 U.S. cents. However, a reversal in attitude towards risk later saw the dollar and yen both rally sending the Aussie back to a low at 90.56 cents. The Aussie is currently trading at 90.76 cents, while it’s lower on the day at ¥81.50 against the Japanese unit.

Canadian dollar –The Canadian dollar remains just a fraction of a penny above 97.00 U.S. cents this morning and has lost some impetus on account of a gentle decline in key crude oil and gold prices. Gold has slipped by $11 per ounce while crude at $80.25 per barrel remains north of psychological support at $80.00.

Andrew Wilkinson

Senior Market Analyst                                                               ibanalyst@interactivebrokers.com

Note: The material presented in this commentary is provided for informational purposes only and is based upon information that is considered to be reliable. However, neither Interactive Brokers LLC nor its affiliates warrant its completeness, accuracy or adequacy and it should not be relied upon as such. Neither IB nor its affiliates are responsible for any errors or omissions or for results obtained from the use of this information. Past performance is not necessarily indicative of future results.

This material is not intended as an offer or solicitation for the purchase or sale of any security or other financial instrument. Securities or other financial instruments mentioned in this material are not suitable for all investors. Any opinions expressed herein are given in good faith, are subject to change without notice, and are only correct as of the stated date of their issue. The information contained herein does not constitute advice on the tax consequences of making any particular investment decision. This material does not take into account your particular investment objectives, financial situations or needs and is not intended as a recommendation to you of any particular securities, financial instruments or strategies. Before investing, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

Andrew Wilkinson

Director of Media Communications

Interactive Brokers Group LLC

8 Greenwich Office Park, Greenwich, CT 06831

(203) 618 8085

Global optimism spurs weaker bond prices

Monday, March 8, 2010

Bond traders are in no mood to be the last one out of the exit today. Friday’s U.S. employment report provided enough reason to start lightening the safe-haven payload of government debt, while the support from French President Sarkozy for the government of Greece was enough to spark a risk revival in equities, commodities and riskier currencies. Such a move argues against the recent bid to bonds and as such 10-year yields are higher across the board, except for those of Greece and Spain.

Eurodollar futures –Former Fed Chairman Paul Volcker speaking in Germany at the weekend argued that now is not the time to dispense with either fiscal or monetary efforts to spur demand. Nevertheless, a revisit to breakeven for U.S. equities for the year based upon building confidence that there is sufficient momentum to deliver a sustainable economic recovery is helping drag bond yields higher. The 10-year yield rose three basis points to start the week and is sitting at 3.71% as the June note future slipped seven ticks to 116-26. Losses for Eurodollar futures are larger at farther maturities with three tick declines evident from June 2011 outwards.

Canada’s 90-day BA’s – The spread between U.S. and Canadian 10-year bonds is once again widening as yield increases are more evident in American government debt. The Canadian dollar has held firm against its U.S. counterpart as investors warm towards the more fiscally sound properties of the Canadian government’s measures. Nevertheless, bill prices are down harder than Eurodollar futures today possibly because rising commodity prices are a sign that a recovering economy may well deliver harsher monetary measures sooner rather than later. The spread between June and December bills continues to stretch wider as a result with the spread of 84 basis points indicating three quarter point rate increases during the second half of 2010.

European short futures – Euribor futures are a little brighter this morning and it is the back end of the curve where the relief pressures are being felt. With money traders concluding that the fallout over Greece will ensure a slower pace of growth, no one is expecting the ECB to raise rates anytime soon. But June bund prices slid earlier as yields rose to 3.18%. Losses have subsequently been curtailed with the June contract having rebounded from an intraday low of 122.26 to stand at 122.46.

British interest rate futures – All is well in the U.K. today. Stocks are up, the pound is perkier and sterling rate futures indicate that the Bank of England can take a nap for the foreseeable future. Gilt prices fell sharply earlier and the June contract slipped to a low of 113.83 at its worst point of the day. The 10-year yield stands at 4.10% and higher by four basis points on the day. Two weekend polls indicated a widening of the opposition Conservative party’s lead over the government heading in to the summer election.

Australian rate futures –Rising regional equity prices and a jump in commodity prices helped depress interest rate futures. The 10-year Australian government bond yield jumped to reflect losses it missed out on after the U.S. employment report. Yields rose 10 basis points to stand at 5.55%. Meanwhile, ahead of its own labor report later this week, 90-day bills slumped up to 10 basis points.

Japan – Government bond yields rose one basis point taking a cue from declining bond prices around the world. Last week’s Nikkei newspaper reported that the Bank of Japan would this week mull any additional measures it could possibly take to help rescue the ailing economy. March JGBs declined just two ticks to close at 140.17.

Andrew Wilkinson

Senior Market Analyst

ibanalyst@interactivebrokers.com

Note: The material presented in this commentary is provided for informational purposes only and is based upon information that is considered to be reliable. However, neither Interactive Brokers LLC nor its affiliates warrant its completeness, accuracy or adequacy and it should not be relied upon as such. Neither IB nor its affiliates are responsible for any errors or omissions or for results obtained from the use of this information. Past performance is not necessarily indicative of future results.

This material is not intended as an offer or solicitation for the purchase or sale of any security or other financial instrument. Securities or other financial instruments mentioned in this material are not suitable for all investors. Any opinions expressed herein are given in good faith, are subject to change without notice, and are only correct as of the stated date of their issue. The information contained herein does not constitute advice on the tax consequences of making any particular investment decision. This material does not take into account your particular investment objectives, financial situations or needs and is not intended as a recommendation to you of any particular securities, financial instruments or strategies. Before investing, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

Three ETF’s for Rising Interest Rates

by Ron Rowland

Originally Published Here

There’s a good reason for this: Debt — or you might call it “leverage” — is the lubricant that keeps the financial markets moving. Imagine a car without oil … it would soon grind to halt. The same is true of the modern economy.

We’ve been enjoying historically low interest rates for the last decade … even more so in the last two years. You know the party is going to end at some point. And I’m beginning to suspect the end will come sooner rather than later.

Debt keeps the economy moving.

Whenever rates move back up, you won’t have to just sit still and accept it. Exchange-traded funds (ETFs) give you many ways to protect your principal and profit from rising rates. Today I’ll tell you about three of them …

Rising Rate Protection ETF #1:
iShares 1-3 Year Treasury ETF (SHY)

A cardinal rule of debt is that overstretched, low-income borrowers pay higher interest rates. And right now no one is more burdened with debt than the U.S. government.

But there’s a twist: The U.S. is a global superpower that controls the world’s reserve currency. So we’ve been able to delay the inevitable, although we can’t do this forever.

When rates do go up, the first domino to fall will be long-term bonds: Treasury debt maturing in ten years or more. This means you can expect a stampede into the short end of the maturity scale. Then the shortest-term Treasury paper will go up in value simply because so many people will want to own it.

SHY is an ETF tailor-made for this scenario. It holds Treasury debt that matures in the 1-3 year range. This is a “sweet spot” for investors: Long enough to give you some time, but short enough to avoid long-term forecasting errors.

Could SHY get hurt if short-term rates go up? Absolutely. However, I still think this ETF will outperform long-term bonds over the next few years, all things considered. So take a look at SHY for money that you need to keep safe.

Rising Rate Protection ETF #2:
ProShares UltraShort 7-10 Year Treasury (PST)

When interest rates go up, bond prices go down. That’s because newly-issued bonds will pay higher rates than older ones, which makes the old ones worth less.

The longer the maturity, the more the price is affected by rising rates. And the change can be significant for bonds in the 7-10 year range. That’s where an inverse ETF like PST can help. PST could rise as much as 10 percent for each 1 percent jump in the 10-year Treasury rate.

Interest rates and bond prices move in opposite directions.

PST does this by shorting Treasury bonds. And while that can work for short-term trades, it’s not a very good long-term strategy …

You see, when you sell bonds short you become indirectly responsible for making interest payments to the bondholders. Moreover, PST employs 2x leverage, so you are effectively paying interest twice.

The best opportunity for making money with PST is to own it for no more than a few weeks when 10-year interest rates are going up. If you hang on after rates level off, you could actually lose ground and your profits will eventually disappear because of the interest payments.

Rising Rate Protection ETF #3:
Direxion Daily 30-Year Treasury Bear 3x Shares (TMV)

If you believe long-term rates are headed up, and soon, TMV could be your ticket to major profits. It’s an inverse ETF that tracks 30-year bond prices with 3x leverage.

Suppose, for instance, interest rates spike higher and the 30-year bond price index falls 5 percent in a day … you can expect TMV to rise 15 percent on that same day. Yowza!

This leverage could also be a ticket to major losses. For example, if your timing is off, even by a few days, you could get your head handed to you. That’s why leveraged ETFs are intended only for the most aggressive investors.

Another thing to consider is the “Daily” part of the name. Leverage in TMV and similar ETFs is reset every day. Over time, this means the leverage factor on your shares could be much more than 300 percent — or much less. I explained how this works in more detail in my Understanding Leveraged ETFs column last year.

Am I telling you not to buy TMV? No, not at all. I’m just telling you to be very, very careful when trading leveraged and inverse ETFs. I don’t want you to learn this lesson the hard way. TMV can be a great tool when used correctly — and at the right time.

When will rates go up? I don’t know. All kind of factors influence the bond market. That’s why you need to start educating yourself now to get familiar with the alternatives that are available. Because whenever the time comes, you want to be ready to make the most of it!

Best wishes,

Ron

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The Canadian economy grew at a rate of 5% in the fourth quarter, Statistics Canada said yesterday, outpacing the bank’s prediction of 3.3% growth. Inflation has also picked up, accelerating at close to the central bank’s 2% target, which has analysts projecting the bank will raise interest rates earlier than previously thought.

“The relative fundamentals of Canada are still there,” said Brian Kim, a currency strategist at UBS AG (NYSE: UBS) in Stamford, Connecticut, before the announcement.

The Canadian dollar rose 1.8% last month against the U.S. dollar, posting its biggest monthly gain since November as exports of crude oil, the country’s largest export, continued to soar. The loonie appreciated as much as 1% yesterday, the currency’s largest daily upswing since Feb. 11.

After policymakers held their last meeting on Jan. 19, BOC officials repeated that the currency’s “persistent strength” could hurt the nation’s economic rebound.

Rates on the Rise in the Land Down Under

For its part, Australia resumed its tightening policy after it paused in February. The RBA insisted that the latest rate increase is just another response to economic conditions that are returning to normal.

“The board judges that with growth likely to be close to trend and inflation close to target over the coming year, it is appropriate for interest rates to be closer to average. Today’s decision is a further step in that process,” RBA Governor Glenn Stevens said in a statement.

The rate increase indicates that Australia will continue to lead the Group of 20 (G20) countries — most of which still have rates set close to zero and continue to face weak conditions — in removing stimulus from the economy.

After the country avoided recession in 2009, the RBA was the first central bank in the G20 to start raising interest rates, beginning in October, and then again in November and December. Stevens last week said rates are still 50 to 100 basis points, or hundredths of a percentage point, below normal.

Economists said further rate rises are on the way but expect the RBA to pause every so often. Most expect the bank to boost rates back into levels appropriate for a steadily growing economy, widely viewed to be between 4.25% and 4.75%.

“They are not indicating any urgency,” Bill Evans, chief economist at Westpac (NYSE ADR: WBK) told The Wall Street Journal.” We think they will go again in a couple of months. It could be three months, it could be two…that may depend on how the inflation numbers look.”

Australia’s economy is in the midst of a rally, with already-low unemployment causing worry about wage pressures, as demand heats up in areas of the economy like mining and energy. Unemployment fell to 5.3% in January, already above levels economists considered full employment.

Treasurer Wayne Swan noted that while some areas of the economy are weak, mining companies are experiencing a boom.

“If you are in resources, the outlook is quite bright, there’s no doubt the economy is strengthening, but if you saw some of the data that came out last week, parts of the economy are still soft,” he told The Journal.

Yields sink along with equities

Thursday, February 25, 2010

Rising risk aversion caused by a threatened downgrade to the sovereign status of Greek debt sent the yield on 10-year German bunds to a cycle low of 3.10% today. Meanwhile the spread between German and Greek maturities widened out 14 basis points to 352 basis points while yields at the two-year Greek maturity shot up like a rocket to 6.28%. The daily change was a surge of 61 basis points. Growing global risk aversion contrasts with a firmer tone from Fed Chairman Ben Bernanke who spoke of the “nascent” U.S. recovery. His continued use of the “extended period” phrase in reference to easy monetary policy provoked a gentler sloping yield curve as buyers locked into declining yields across all maturities.

Eurodollar futures – In addition to the soothing nature of Mr. Bernanke’s words, a slump in new home sales and a decline in mortgage lending attracted Eurodollar buyers in the belief that there are unlikely to be any near or even medium term changes to short term interest rates. The spread mapping the gradient of the one-year curve starting next month eased to 90 basis points today with a four basis point rally for the March 2011 contract comparing to a two basis point rally in the contract expiring next month. The flattening nature of the spread compares to a far steeper 160 basis point curve evident at the turn of the year.

March treasury notes added a further half point to 118-16 this morning as demand for the relative safety of U.S. government debt continues to rebound from lows seen last Friday when the 10-year yield spiked to 3.90%. The rally today has sent the yield down to 3.63% as global risk aversion manifests itself in triple digit losses for the Dow industrials index.

Initial jobless claims data reported on Thursday indicated deterioration in the labor market with claims through last Saturday uncomfortably close to 500,000. The market has become accustomed to a gradual improvement in this data series, which has foreshadowed an underlying improvement in job creation. Unless this week’s data is well and truly accounted for by an administrative backlog on account of adverse weather-related conditions, the economy just took a step backwards and one that’s uncomfortably consistent with the reported downturn in consumer confidence by the Conference Board.

European short futures – Euroland market action continues to react to the ticking time bombs of peripheral European governments. When Standard & Poors rating agency announced overnight that it might further downgrade the long term credit rating of Greece before the end of March, investors plundered the domestic bond market and sent investors scurrying for the relative safety of core German bunds. The March bund contract is currently higher by 22 ticks to 124.23 driving prices are following through on.

Euribor futures continue to push to new highs as the cash curve slips and investors consider the double-whammy being served up. Ongoing fiscal austerity will slow Eurozone demand, while making the ECB’s retreat from ultra low interest rates ever harder. As bond yields push lower investors may yet consider how the monetary-fiscal mix is now creating tighter conditions that could conceivably provoke calls for further monetary relaxation from the ECB. The official policy rate is still at twice the interest rate in the U.K. and four times that of the U.S.

British interest rate futures – The British yield curve continues to flatten following official color on the hapless state of the domestic economy with its downside risks. And while the pound is also falling investors continue to assume low interest rates will remain in place for the months ahead.

Next week represents the one-year anniversary of the Bank of England’s final half point cut to leave its bank rate at 0.5%. At that time the March 2011 future reached a peak implying that rates would rise sharply over the next two years through expiration. The implied yield that day reached 2.67% indicating a strong degree of optimism that monetary policy would heal the economy looking forward. Indeed it was not until October 2009 that the March contract traded at a lower implied yield as slowing growth rekindled doubts that interest rates would be lifted. Since then and with the exception of a hiccup at the start of 2010 the March contract has moved higher at a 45 degree angle as implied yields slip.

Today March 2011 contract is priced at 98.58 and still implies a yield of 1.42% but it does illustrate the ongoing reining in of expectations over the future course of monetary policy. The March 2010/ March 2011 calendar spread has halved from 150 basis points on January 21 to 75 basis points today. That’s a major flattening of interest rate expectations especially against the backdrop of ongoing chatter about the neck brace the government finds itself in over Britain’s comparable debt burden.

Australian rate futures –A jump in the value of the Japanese yen knocked confidence in exporters share prices and added to already broadly weaker stock market prices as risk aversion mounted. Australian government bond prices continued to rise as regional stocks fell. The 10-year note slipped to 5.48% while shorter term bill futures ticked marginally higher ahead of next week’s RBA meeting. The December contract has a huge range of 95.26 seen after the RBA unexpectedly left rates unchanged and a low of 94.87 when the subsequently released minutes revealed more rate increases on the cards. Today the contract is trading at 95.04 implying a yield of 4.96% by the end of this year.

Canada’s 90-day BA’s – The 10-year Canadian yield continues to shadow comparable 10-year U.S> treasuries with the yield on the decline by five basis points today to 3.39%. Bill prices gained by five basis points with the June10/ Jun11 calendar spread at 142 basis points today, which compares to a 120 bp spread for the equivalent Eurodollar spread.

Japan – Weakness in regional stocks saw government bond yields sink to a seven week low at 1.28%. Next week brings news on consumer prices, expected to show ongoing deflation.

Andrew Wilkinson

Senior Market Analyst                                                              

ibanalyst@interactivebrokers.com

Note: The material presented in this commentary is provided for informational purposes only and is based upon information that is considered to be reliable. However, neither Interactive Brokers LLC nor its affiliates warrant its completeness, accuracy or adequacy and it should not be relied upon as such. Neither IB nor its affiliates are responsible for any errors or omissions or for results obtained from the use of this information. Past performance is not necessarily indicative of future results.

This material is not intended as an offer or solicitation for the purchase or sale of any security or other financial instrument. Securities or other financial instruments mentioned in this material are not suitable for all investors. Any opinions expressed herein are given in good faith, are subject to change without notice, and are only correct as of the stated date of their issue. The information contained herein does not constitute advice on the tax consequences of making any particular investment decision. This material does not take into account your particular investment objectives, financial situations or needs and is not intended as a recommendation to you of any particular securities, financial instruments or strategies. Before investing, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.

Wednesday February 25, 2010

Global yield curves are marginally flatter at the end of a week that delivered fresh economic worries around the world, compounded by fresh signs of smoke in Europe where investors responded to threats of a Greek downgrade. Long yields are firmer in price while short-dated futures contracts are lower by a similar amount. The net effect confirms the response towards flatter yields seen during the week. Interest rate expectations continue to focus on near-zero rates for an extended period.

Eurodollar futures – It’s hard to determine what reaction interest rate markets should have to Friday’s GDP report. The expected upwards revision to fourth quarter growth was in-line with expectations at 5.9% and higher than the preliminary 5.7% reading. The improvement stemmed from a sharp reduction in the pace of inventory declines as businesses realized that stocks were already mean and lean. Final demand data was actually revised lower and portrays a slightly more docile consumer than at first blush. So we have a blistering headline rebound weighed upon by lackluster consumer spending. More recent data has also raised eyebrows as fresh weakness is apparent in the housing market where data for construction and transactions are both pointing to another tepid spring for realtors and builders.

Existing home sales in the U.S. fell 7.2% in January bringing the annualized pace to the lowest reading in seven months. Meanwhile a University of Michigan consumer sentiment reading for February declined at the margin pretty much in line with market expectations. All of today’s data gives cause for bonds to keep a positive tone sending yields lower. Meanwhile the weaker consumer confidence data and lacking conviction in the housing market was enough to swing Eurodollars from minor intraday losses to gains. March treasury note futures are eight ticks higher at 118-25 to yield 3.62%. The December Eurodollar contract is trading at an implied 0.81% yield.

European short futures – German bunds are pushing intraday heights heading into the final hours of European trading. The March contract is up 14 ticks at 124.44 and is challenging the 124.52 peak of February 2 as investors worry about weekend prospects for negative weekend developments on the Greek story.

British interest rate futures – British growth was also revised higher earlier today with the fourth quarter expansion lifted to 0.3% from 0.1%. But a downward revision to the third quarter data meant a large final quarter contraction of 3.3% compared to the 3.2% announced last month, which offset today’s better data. March gilts are ending the session just about unchanged at 115.75 while short sterling futures are about two ticks weaker in price.

Australian rate futures – Aussie bills also dipped just slightly ahead of next week’s RBA meeting at which dealers’ expectations over an interest rate increases are evenly split. Firm data from Japan overnight indicates ongoing Asian market recovery.

Canada’s 90-day BA’s –Canadian bill futures are unchanged to higher along the strip with government bond prices once again on the rise as yields fall as the yield curve continues to flatten.

Japan –A recovery for stocks domestically and firm retail sales data helped confidence return a little to Japanese markets. Eyes continue to remain fixed on the Toyota recall. Today’s strong reading for industrial production showed a gain for January of 2.6% blowing away a 1.1% forecast but was not enough to change 10-year note yields standing at 1.30%.

Andrew Wilkinson
Senior Market Analyst
ibanalyst@interactivebrokers.com

Note: The material presented in this commentary is provided for informational purposes only and is based upon information that is considered to be reliable. However, neither Interactive Brokers LLC nor its affiliates warrant its completeness, accuracy or adequacy and it should not be relied upon as such. Neither IB nor its affiliates are responsible for any errors or omissions or for results obtained from the use of this information. Past performance is not necessarily indicative of future results.

This material is not intended as an offer or solicitation for the purchase or sale of any security or other financial instrument. Securities or other financial instruments mentioned in this material are not suitable for all investors. Any opinions expressed herein are given in good faith, are subject to change without notice, and are only correct as of the stated date of their issue. The information contained herein does not constitute advice on the tax consequences of making any particular investment decision. This material does not take into account your particular investment objectives, financial situations or needs and is not intended as a recommendation to you of any particular securities, financial instruments or strategies. Before investing, you should consider whether it is suitable for your particular circumstances and, as necessary, seek professional advice.