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IRA EPSTEIN & COMPANY
626 West Jackson, Chicago, Illinois
(November 11, 1997) FINANCIAL INSTRUMENTS–T-BONDS–Tuesday is Veterans' Day (the day that this report was written), and the Treasury bond futures market was closed today. This gives us a chance to take a step back and look at what the state of the bond market is at this juncture.
On Wednesday, there is an FOMC meeting where the Federal Reserve will decide whether or not to raise interest rates. In my opinion, the chances of an interest rate hike are pretty slim.
The reason: recent volatility in world stock markets.
If the Federal Reserve Board raises interest rates, then the cost of money increases. If the cost of money increases then business expansion should slow down. In my experience, when businesses reconsider expanding, the economy slows down. This is very important to consider when the latest unemployment number was 4.7%, the lowest it has been since 1973.
One reason the Federal Reserve strives to slowdown the economy is inflation fears. If it is hard to get good workers at present wage prices, then businesses might consider paying more in order to get the help they need. If this happens, then businesses will have to raise their prices, at least in theory.
But if the stock market is unstable, any hint that business growth might slow down could cause stock prices to fall (because of a perceived fall in future earnings). I believe this instability will prompt the Federal Reserve to keep rates where they are for now.
RECOMMENDATIONS–The question is how can one take advantage of this scenario in the bond market. Well, tomorrow there could be a positive reaction to this news and the bond market could rally. The December bond future is currently at very high levels. So, when the markets get volatile and investors are unsure about where to put their capital, they tend to go to the bond market. Then, when people feel that the volatility is more palatable, they usually put their capital back into riskier investments, which in theory puts pressure on to drive the bond future lower.
My recommendation is to go long the bond future in the short term, but go short the bond future in the longer term because it is unlikely that interest rates will stay unchanged, and the stock market will eventually come back to “normal.”
Ole Rollag
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