Saturday, January 8, 2011

Falling Bond Prices Effect on the Energy Complex

Ben Bernanke and the US Federal Reserve are in the process of buying up $600 billion in treasuries in hopes of keeping interest rates low to help stimulate the economy. Bonds, however, are misbehaving. Interest rates on the ten year note is approaching critical technical levels that if broken, will likely set the stage for a secular bear market in bonds. Mr. Market is in the process of breaking apart long held economic theories.

Theoretical economics can be completely mind blowing. Yet no matter how complex the theory, in the long run, it will always need to obey the very simple laws of supply and demand. The acid test of any economic theory is whether or not a hypothetical idea plays out in the market. Ben Bernanke is hoping that injecting $600 billion into the economy buying treasuries will force interest rates down. Yet interest rates are going in the opposite direction. Why? And will this have any effect on the energy market?

The simple answer to why interest rates are heading up instead of down is that money flows are moving out of bonds with fears of future inflation diluting value.

Bonds have been in a secular bull market for the past twenty years. Bond traders are now carefully monitoring two year resistance of 4% on the ten year. Should this level give way the next major line of resistance comes in at 5.5%. A breach of interest rates above 5.5% by either the ten year or thirty year bond will be a strong signal to most bond traders that the long run of the bond bull market is over and a new secular bear market has begun.

If the bond market turns secularly bearish, will this tame the relentless bull market in energy? Probably not much. Upward trending interest rates are not good for any economy. Higher borrowing costs will be past along to consumers. The ultimate result is rising prices; inflation.

Crude oil remains a scarce resource. Light crude oil even more so. Long term continuation of falling bond prices will eventually lead to another recession. This may not happen for several years. Until then, demand for crude and its refined products will continue unabated supporting prices, keeping the secular crude bull market in place for several years to come.

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