Why rising interest rates matter

The major
indexes finished mixed
again in what turned out to be a rather choppy week of
trading. After a downside reversal Monday, equities traded modestly higher over
the following three sessions. This came despite a continued rise in the 10-year
note yield and elevated commodity prices. However, on Friday, things changed as
the equities markets suffered a sharp setback and gave up most of their gains
from prior sessions. Expectations of higher rates along the yield curve
appeared to be the catalyst for Friday’s decline. At the same time, the key
averages had become short-term overbought, so a pullback was to be expected at
some point.

Up until
Friday, the big theme was how resilient equities were in the face of many
negative factors. All it took was one decline and suddenly rising rates were back
to being a concern. Despite the claims of many, rising rates along the yield
curve do matter. It’s very simple. Our economy today is extremely leveraged,
and therefore is extra sensitive to the direction of interest rates. Thus far,
rising rates have not mattered too much. But things are now changing. Real
estate sales have plunged on a national basis, while prices are finally starting
to decline. Also, many of the prior adjustable rate mortgages are now starting
to float. This means sharply higher monthly mortgage payments for consumers,
and only a rate cutting cycle by the Fed will save the day. There is a
possibility of refinancing in “gimmick” loans such as negative amortization, but
banks are becoming much tighter with lending standards in the current
environment. Furthermore, the lack of spread between short and long rates makes
taking on risk much less profitable for lenders.

everything above taking place, it’s very likely that we could see a consumer
retrenchment in the 2nd half of 2006. At this point, a soft landing scenario
may still be possible, but further hikes by the Fed significantly increase the
chances of a hard landing for both the economy and equities. Consequently, as
long as the Fed maintains a bias towards further hikes, it’s best to proceed
with caution on the long side. Friday’s retreat could very well be the start of
an overdue correction.

Daily Pivots for 4-10-06

Symbol Pivot R1 R2 R3 S1 S2 S3
INDU 11165.79 11223.55 11327.07 11384.83 11062.27 11004.51 10900.99
SPX 1301.25 1308.32 1321.14 1328.21 1288.43 1281.36 1268.54
ES M6 1309.75 1318.25 1332.50 1341.00 1295.50 1287.00 1272.75
SP M6 1309.17 1316.73 1329.57 1337.13 1296.33 1288.77 1275.93
YM M6 11225.00 11287.00 11390.00 11452.00 11122.00 11060.00 10957.00
BKX 107.13 107.78 108.77 109.42 106.14 105.49 104.50
SOX 518.38 524.30 533.66 539.58 509.02 503.10 493.74

Please feel free to email me with any questions
you might have, and have a great trading week!

Chris Curran


Chris Curran started his trading career at the
age of 22 with a national brokerage firm. He combines fundamental and technical
analysis to get the big picture on the market. Chris has been trading for 15
years, starting full time in 1997, and has never had a losing year as a
full-time trader.