Are Higher Interest Rates the New Normal?

The H.R. 325 "No Budget, No Pay Act Act of 2013" was signed into law yesterday. What kind of impact will it have on the Treasury market?  Are higher interest rates the "new normal?" Before tackling that question, here's what the temporary bill does:

• Temporarily suspends the nation's borrowing limit until May 18, 2013;• Withholds pay for lawmakers starting on April 16 until they pass a 2014 budget resolution;• Prevents the U.S. from defaulting on its debt.

Just ahead are $85.3 billion in automatic spending cuts or "sequestration" in defense and domestic programs, which go into effect on March 1 if Congress doesn't intervene.

Meanwhile, interest rates on U.S. Treasuries (NYSEARCA:IEF) have edged higher. The 10-year U.S. Treasury bond has spiked above 2% and 30-year U.S. Treasuries (^TYX) have jumped 0.39% in Q4 to 3.22%.

"Politics" has dominated our short list of mega investment themes over the past several months. In a post-Fiscal Cliff update via the ETF Profit Strategy Newsletter we wrote:

"Contrary to declarations of 'victory' for the economy, the $607 billion Fiscal Cliff ushered in a new era of higher taxes and more government. The debt debate paves the way for more media noise, more political instability and yet another credit rating downgrade for the U.S. government."

Bull Market in Spending 

The trajectory of higher debt and higher spending for the U.S. government is still trending upward. Just five short years ago, total public debt was less than $10 trillion. (See chart below) In early January 2013, public debt was around $11.57 trillion plus another $4.85 trillion in intra-governmental holdings. The combined amount totals $16.434 trillion or about 73% of GDP.The largest foreign holders of U.S. debt are China (NYSEARCA:CYB) and Japan (NYSEARCA:FXY), with each holding just over $1.1 trillion. Losses at the Federal Reserve?

The Federal Reserve's balance sheet just crossed above $3 trillion as it continues to snap up Treasury debt (NYSEARCA:TLT) to the tune of $85 billion per month.

Although the Fed can try to control the supply/demand of U.S. Treasury debt, it cannot fix borrowing rates. It's the credit market that ultimately determines what the U.S. should pay on its debt. And the continued uptick in Treasury yields could subject Bernanke & Co. to billions of dollars in market losses as the value of the Federal Reserve's Treasury holdings decline in value. 

On Dec.12, we issued the following alert in our ETF Technical Forecast for long-term U.S. Treasuries (NYSEARCA:TLT):

"Today's selloff in U.S. Treasuries was even more interesting though because it aligned nicely with the rising red trendline and it provides a high probability trade setup. If TLT continues to sell off tomorrow and breaks the support trendline, aggressive traders can buy the TBF (unlevered) or the TBT (levered) to take advantage of the short side. TBF and TBT should rise when the TLT falls.  The 200 day moving average for TLT is $121.20 and rising and monthly S1 Pivot are just below and could be a target for the selloff. The 200 day MA held as support at the previous two price lows, so the action around it will be telling."

Since our December Treasury alert, the ProShares UltraShort 20+ Year Treasury (NYSEARCA:TBT) is ahead by 9.6% while the even more aggressive Direxion Daily 20+ Yr Trsy Bear 3X Shares (NYSEARCA:TMV) is up by 13.92%.

With another downgrade in the U.S. government's credit rating yet ahead, there's still more money to be made for Treasury traders who are correctly aligned on the right side of the market.

The ETF Profit Strategy Newsletter uses relative strength along with common sense technical analysis to identify high probability trades on ETFs linked to stocks, bonds, currencies, and commodities.  Follow us on Twitter @ ETFguide