The investment world is breathless with anticipation for Fed Chair Yellen’s testimony today in front of Congress. The uncertainty if and when the Federal Reserve will raise the Fed Fund rates, a rate that has been (basically) at zero since late 2008, and has not been increased since mid 2006
A look at the recent sell off in the iShares 20 yr Bond ETF (TLT) and the Utilities Spyder ETF (XLU) over the last month (both down about 7.5% from 52 week and multi-year highs) suggests that investors are positioning for a higher rate environment sooner than later.
On CNBC’s Fast Money last night we talked with astute market strategist Larry McDonald, from Societe Generale, who gave his thoughts on the timing of rate increases and his belief as to why the TLT and the XLU are “screaming buys”, watch here:
Larry thinks (in the near term) that Treasuries and Utility stocks are oversold. And that the Fed Chair is going to be more dovish than most expect, causing a demand for yield.
I am just a simple stock and options guy, but my sense is that the capitulation that Larry speaks of was the melt up into the end of January, and that the recent sharp decline in the TLT and the XLU was merely a normalization of the two month price action seeing re-tracements back to the breakout levels. If Ms. Yellen does as Larry suggests, than there will be a quick trade higher in both.
In late December I took a bearish view on the XLU (here) and in mid Jan on the TLT (here) with the thought that Utilities were way to expensive relative to expected growth, and were merely proxy for investor demand for yield, and the TLT would see a moderation in demand on the slightest whiff of rate increases at the March FOMC meeting.
As usual, I was a bit early on both. I got paid on XLU (here) but stopped out in the melt up in TLT (here).
But the thesis still stands. If this week’s commentary is not as dovish as some expect, leaving the door open for a change in language at the March FOMC meeting signaling an rate increase as soon as June, then both of these etfs will see far lower lows. If Ms. Yellen is a tad more dovish than the Jan Fed minutes, and these two don’t rally much, then the fix is in and market participants don’t buy it.
On Friday morning March 6th we will get the Feb jobs data. If we see the slightest bit of wage inflation then high yielding sectors like utilities will likely decline another 10%, and maybe just maybe we see another Fed induced bubble get pricked in Treasuries (we have already seen the commodity bubble burst).