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THE REAPER
P.O. Box 84901, Phoenix, Arizona
(October 23, 1997) FINANCIAL INSTRUMENTS: INTEREST RATES–Technically, “the policeman of the markets,” December T-bonds, are caught in a trading range between 118 resistance and 112 support, with 114-115 as the pivot point. It may be difficult for T-bonds to rally, even though deflation should send T-bonds higher. Why? Because U.S. interest rates have to stay high to compete with now rising European interest rates. U.S. interest rates also will tend to stay lofty to encourage foreign investor's in Europe, Latin America and Asia to continue to hold U.S. Treasury debt. Commercial traders are bearish T-bonds. Seasonally, bonds normally top in mid-late September and swing lower through early November. With the collapse of the Far East stock markets hitting the rest of the world, it is unlikely the Fed will raise interest rates November 12. The real interest (in any case) is about 3.2%, the average running at about 2.8% since 1981 and 1.87% since 1958. Thus, if the Fed raises interest rates, it will be because other countries are raising interest rates, forcing the Fed to be competitive to support the U.S. Dollar and Treasury bond market. Europe is looking presently at aligning interest rates in the EMU between member states. This is supportive for the German D-mark particularly. Of course, a severe deflation could be bullish for bonds in a sharp stock market sell off, forcing the Fed to lower U.S. interest rates. Additionally, the shrinking U.S. budget deficit is bullish for bonds short term, but this deficit could explode in a deflationary recession.
RECOMMENDATION–Investors who lightly purchase put options in December or March T-bonds on scale-up strength–hold. Hold Benham European Government Bond Fund and Benham Target Maturities Trust 2005, where partial profits have been taken. Futures investors may purchase December T-bonds on a strong close above 118-00 with a 115-00 open protective stop, holding for an upside acceleration. Futures investors may sell December T-bonds short on a weak close below 114-16 with 116-05 open protective stops, holding for a test and possibly a break below 112.
R.E. McMaster, Jr.
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