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Why Aren’t Long Term Interest Rates Skyrocketing? A Look At “The Cursed Trade”

by Brett on August 5, 2010

Has any trade over the last few years frustrated more sophisticated investors than the “one-way” bet on rising long-term government interest rates?

For the last 2 or 3 years, many (including myself) have been piling into ETFs (like TBT) that act as short proxies for rising long term interest rates.  And the logic has been so sound, it’s maddening!

It’s tough to argue with this sequential logic:

Step 1 – The government piles on more debt than it can handle

Step 2 – Long-term bond buyers get nervous

Step 3 – Interest rates begin to rise due to added risk

Step 4 – Long term interest rates go to the moon as the bond vigilantes ride into town

It all makes perfect sense – except that we’re STILL stuck on step 2!

While I do believe that someday interest rates on long-term government debt must rise as a result of the fiscal profligacy being exhibited by US leaders – it appears that this trade is going to take much longer to play out than many anticipated.  In fact, it probably already has.

The only justification I can come up with is deflation.  Perhaps deflationary forces are overwhelming all other factors right now.  If we were heading into the inflationary environment that many had predicted would be here already, then we’d expect long-term rates to be north of 5% and climbing by now.

One new wrinkle is that, all of a sudden, it seems that everyone is concerned about deflation – not inflation:

You’d have to think this topic will be on the agenda at the FOMC meeting next week.  Can Ben & Co fire up the printing presses before credit destruction takes hold?  Will they even be allowed to fire up the printing presses?  We shall see!


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More on this topic (What's this?)
Equity Risk Premium In A Rising Interest Rate Environment
Anticipating The Rate Hike
Read more on Interest Rates at Wikinvest

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