This Chart Says Rates Will Rise Again -- Even Without The Fed

Adam Fischbaum's picture

Wednesday, June 15, 2016 - 12:30pm

by Adam Fischbaum

For the first half of this year, pundits and investors alike have been wringing their hands in anticipation of the Federal Reserve raising its benchmark Fed funds rate another quarter of a percent. But indications are strong that Fed Chair Yellen isn't going to pull the trigger at the June meeting like she did in December of 2015. Seems like investors dodged that bullet, right?  Wrong.

Rates are going to go up on their own without any help from the Fed.

Over the last five years, the yield on the 10-year U.S. Treasury, the benchmark for all interest rates, rose an average of 11.2% during the month of June. Here's proof.

Will this year be any different? Five years straight is a strong indicator. And although of late equity markets have been a little weak, which will keep yields low due to investors fleeing to "safety", the evidence is still strong for an organic rise in rates.

Why did rates rise? The Fed only intervened once during the time period, and that wasn't until December of 2015. Maybe we should blame the U.S. dollar.

Here's a five year study of the strength of the U.S. dollar. As you can see, the dollar rallied in strength just before backing off in the summertime. Historically, a weaker dollar is an inflationary sign and inflation is usually accompanied by higher interest rates or bond yields. 

Now, the dollar spent most of last year on a tear. But that rally is starting to look a little long in the tooth. Combined with a pattern like seasonal weakness, the wiggles on the charts (remember...I am NOT a certified wiggle reader) would tell us that the dollar should give up some ground soon, weakening bond prices with it and bumping up rates.

Here's how investors can profit.

ProShares Ultra Short 20+ year Treasury ETF (NYSE: TBT) -- Using TBT is probably one of the most obvious ways to trade rising rates. Rising bond yields mean that bond prices are falling. Effectively, this ETF is a way to short long maturity U.S. Treasuries. The value of the index the ETF is linked to should rise is treasury prices go down. TBT shares currently trade around $33.58; right around their 52-week low.

Energy Select Sector SPDR ETF (NYSE: XLE) -- Inflation, even the slightest amount, usually boosts energy prices. Why not own a basket of energy related stocks in ETF form? After the carnage in the energy sector last year, XLE has enjoyed a 32% rally so far this year from its bottom at the end of 2015. Shares are still trading at a 14% discount to their 52-week high and have come back 2.7% from a recent high of around $69 to about $67.13. There's also a 2.96% dividend yield. 

Potash Corp of Saskatchewan (NYSE: POT) -- Physical commodities always benefit in higher rate/weaker dollar environments. Globally, commodities such as energy and agricultural products are priced in dollars. A weaker dollar props up commodity prices. As the world's largest producer of potash, a vital widely used fertilizer, POT shares have always been a bellwether proxy for the health of commodity prices. Shares are off over 47% year over year. There's some value there at $16.86 a share with a 8.2% trailing twelve-month dividend yield.

Risks To Consider: The biggest risk to this idea is that it doesn't happen. This could be the year that defies the pattern. While this would spell bad news for holding TBT, my other two recommendations, XLE and POT, have decent yields which compensate the investor for his risk. TBT involves more risk than most ETFs in that it uses a shorting strategy and internal leverage. Investors should perform additional due diligence. Also, investors should have an entry and exit point determined before holding TBT.

Action To Take: A five year trend is a decent enough time period to spot a pattern. Clearly, one is established supporting the confluence of rising interest rates and a falling dollar. The best trade for this event is a "short" U.S. Treasury/long commodity position. XLE and POT provide a blended yield of better than 5.5% while TBT provides direct exposure in order to benefit from rising yields and falling bond prices. 

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Disclosure: Adam Fischbaum holds TBT in managed client accounts

Adam Fischbaum does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.