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How to profit from Fed policy when rates go up?
Old 08-29-2010, 09:09 AM   #1
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How to profit from Fed policy when rates go up?

I have most times made a little money when the Feds start lowering interest rates via bonds and a few utilities. In my investing lifetime, rates have never been this low. Eventually I assume the Fed will raise rates. I expect bonds to decline over the course of the rise and the stock market to decline briefly. I have never really invested much taking advantage of the down side such as selling short and have never used margin. I have bought/sold puts, calls, and covered calls.

My questions are: What financial instrument(s) is available to directly profit from rising interest rates relative to bonds?

What would you use relative to the stock market that will probably have a shorter duration?

I can take care of the When, it is the What I am wondering about.
Thanks.
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Old 08-29-2010, 09:50 AM   #2
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A really easy slam dunk IMO would be to go short agency mortgage REITs. These things borrow money short term to buy Fannie and Freddie MBS (long term securities). They will get crushed when rates reverse. You might try to find one with the highest leverage ratio, or just short/but puts on a slew of them. Examples include NLY (the biggest), AGNC, MFA, CMO and ANH. The problem with this trade is that you have to get the tiing pretty much exactly right or you will get killed.
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Old 08-29-2010, 11:19 AM   #3
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My questions are: What financial instrument(s) is available to directly profit from rising interest rates relative to bonds?
You could short the ETF. Also, look at RYDEX funds and ETFs. They have a mind boggling variety of ETFs & funds for every situation.
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Old 08-29-2010, 12:34 PM   #4
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I wonder if an analogy to Japan is in order here. Japanese interest rates have been this low since 1996. Rather than plan for when rates go back up, I would be planning for how to make money like the Japanese have made money in the last 15 years.
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Old 08-29-2010, 12:46 PM   #5
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I wonder if an analogy to Japan is in order here. Japanese interest rates have been this low since 1996. Rather than plan for when rates go back up, I would be planning for how to make money like the Japanese have made money in the last 15 years.
That is why I recommend people begin to learn about foreign currencies. Look up past articles about the JapY/Aus$ carry trade. People in Japan sold Yen for Aus$ paying a higher interest rate.
However, with all central banks under pressure to keep interest rates low, that strategy might not work as well.
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Old 08-29-2010, 06:08 PM   #6
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A year or so ago, when I was sure that the massive borrowing was going to cause inflation and interest rates to shoot up. I really looked at ways of of doing this.

I was pretty frustrated because while there are lots of exotic ETFs, or you could use future contracts or options on future contracts on T-Bonds. All of these had disadvantages, contango being the primary one. At fundamental level, my and your credit rating is much worse than Uncle Sams (not sure if they should be true but it is) so we can't short Treasury bonds. I eventually gave up on the quest, and I am glad I did since deflation and lower interest rates actually occurred not the opposite like I predicted.

If you want to profit by rising interest rates. I think step one is not own any bonds, put fixed income portion in either short-term bonds or CDs. (Penfed had 5%, 10 years ones coming up in Jan). Step 2 is if if you are really confident than take advantage of these historically low rates is lock them in by borrowing, a mortgage or HELOC works best. Then you can look at using some of the more exotic methods.
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Old 08-29-2010, 06:59 PM   #7
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Now that I made the comment about Japanese interest rates, I may have to look into long-term 5% CDs. They will look real nice if interest rates stay at 0.1% for the next 10 years.
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Old 08-29-2010, 07:10 PM   #8
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I may have to look into long-term 5% CDs.
You can get them in foreign currencies also.
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Old 08-29-2010, 07:25 PM   #9
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If you believe that US interest rates are going to rise, you could:

1. refinance any existing mortgage for the longest term possible

2. consider going long the USD against other currencies which are not raising interest rates (actually long USD/short JPY looks a good bet at the moment assuming a decent time horizon)

3. for bonds you could consider very long term corporates with floating rate resets (?)

I am wary about some of the ETFs because of the contango others mention.
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Old 08-30-2010, 10:44 AM   #10
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That is why I recommend people begin to learn about foreign currencies. Look up past articles about the JapY/Aus$ carry trade. People in Japan sold Yen for Aus$ paying a higher interest rate.
However, with all central banks under pressure to keep interest rates low, that strategy might not work as well.
When you look them up be sure to read about what happened during 2008/9 .

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Old 08-30-2010, 10:48 AM   #11
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A portfolio of stocks, bonds, and cash, consistent with your appetite for risk?
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Old 08-30-2010, 11:51 AM   #12
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I wonder if an analogy to Japan is in order here. Japanese interest rates have been this low since 1996. Rather than plan for when rates go back up, I would be planning for how to make money like the Japanese have made money in the last 15 years.
BINGO! That is my operating thesis. Absolute bare minimum for rate increase will be 3 years plus and I wouldn't be surprised at all if it's ten years. Bernanke has made it plain as day he is going to follow his battle plan come Hell or High Water. Regardless of the fact that there is a demand problem for credit, he will continue to increase the supply of credit.
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Old 08-30-2010, 05:43 PM   #13
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BINGO! That is my operating thesis. Absolute bare minimum for rate increase will be 3 years plus and I wouldn't be surprised at all if it's ten years. Bernanke has made it plain as day he is going to follow his battle plan come Hell or High Water. Regardless of the fact that there is a demand problem for credit, he will continue to increase the supply of credit.

I don't think there is a demand problem for credit. I think there is just a lack of demand for credit who have the likelyhood/ability to pay it back.
i.e. there are plenty of folks struggling to pay off underwater mortgage, who have suffered a loss of income who be delighted to take on additional credit. Amazingly the banks etc have decided that it is important that when people borrow money it gets paid back.

The same think is true for commercial lending, plenty of overextended business in the real estate, home builders, casino etc would love to be able to borrow more money.

On the other hand for folks like me and business with good credit there is very little demand for credit even at low rates, be because the opportunities to make money seem very small.
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Old 08-30-2010, 05:51 PM   #14
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On the other hand for folks like me and business with good credit there is very little demand for credit even at low rates, be because the opportunities to make money seem very small.
Like I said... there is no demand for credit (bad credit borrowers never enter the equation because, wait for it, they're bad credit risks).
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