In this column five years ago, I called currency markets "the new Wild West" and predicted that foreign exchange trading would "soon become the hottest game in town."
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Since then, forex trading has grown by well over 20%, coming off a 72% increase that preceded it between 2004 and 2007. According to industry reports, the activity has come from "other financial institutions," namely hedge funds, high-frequency-traders and retail investors.
A wide assortment of new products have been launched to play the trend, from baskets of currencies like WisdomTree Dreyfus Emerging Currency Fund (CEW) or WisdomTree Dreyfus Commodity Currency Fund (CCX) to broad-based bets on the dollar, such as PowerShares DB USD Index Bullish (UUP) or PowerShares DB USD Index Bearish (UDN) .
Once again I'm going to again step out on a limb and predict this time that fixed income and interest rates will soon dominate investor attention just as foreign exchange has over the half past decade. Fueling the interest will be the end of the near 30-year bull market in U.S. Treasuries, whose yields have actually risen since the Fed's most recent January promise to keep them low through 2014. As we wrote last month, the yield on the 2-year note most directly influenced by Federal policy how sits at 0.30%, the highest since last August but still well below the 4% the security yielded as recent as 2007.
That's helped shares of funds like iPath US Treasury 2 Year Bear ETN (DTUS), ProShares Short 20+ Year Treasury (TBF), and ProShares UltraShort Lehman 20+ (TBT), all which seek to profit, with leverage and without, from higher rates.
The Fed's persistent assurances of their intent to keep interest rates low reminds me of the United Kingdom's infamous 1999 public announcement to sell half the country's gold reserves. At the time, gold was trading at $283 an ounce, a nearly 20-year low, and began a record run to all-time-highs not long after the U.K. finished selling in 2002, suggesting that big public governmental market actions often mark the end of a move rather than the beginning of one.
It's been well over a generation since U.S. investors dealt with an inflationary period of higher interest rates -- so long in fact that most of today's investment class has little memory of investing in such an environment. And even though U.S. bond investors have lost money this year, they continue to pour money into bond funds, more than $5 billion a week in February in addition to positive inflows every month for the past year, save one. It's not dissimilar to the 1990s bull market, where inflows into growth mutual funds finally crested in February 2000, just as the market was peaking.
When bond ETFs were first introduced in 2002, we called them a "major opportunity for income investors looking to take their game to the next level." Buyers flocked to funds as rates dropped throughout the decade, and 9 new bond ETFs were introduced last month alone, including niche offers like iShares Industrials Sector Bond Fund (ENGN) and iShares Financials Sector Bond Fund (MONY), the first bond ETFs which focus on specific industries.
While the new products offer even greater flexibility to investors, including the opportunity to hedge or assume specific industry credit risk, their popularity, not to mention that of star manager Bill Gross's recently launched Pimco Total Return Exchange Traded Fund (TRXT) ETF also suggests the decades-long bull run in bonds could be coming to a close. Longtime market watchers might recall the rash of ultra-aggressive technology mutual funds which debuted in early 2000, just as that bull market was on its final legs.
One colloquial indicator the bond market could be headed for a fall can be construed from a new building's construction. As was reported last week, bond giant Pimco was doubling its current office space by moving into a new sleek new $60 million tower (dubbed the "Taj Mahal" by one blogger) in one of California's priciest neighborhoods.
Building Going Up, Bonds Going Down?
Source: CalculatedRiskBlog.comPimco's new tower headquarters under construction in Newport Beach, CA
As I wrote last year, stock market returns were 10% lower, on average, after construction of a record-breaking skyscraper than during other periods. Ground was broken on the Empire State Building, for example, in 1930, and the Dow didn't trade higher for the next 20 years. Given Pimco's stature in fixed income, including managing the world's largest bond fund, their new HQ could be the indicator that the relentless bull market in Treasuries is done. I've placed my bets. Time to make yours.
Jonathan Hoenig is managing member at Capitalistpig Hedge Fund LLC
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