Thursday, April 28, 2005

Bill Cara shares insights on fed rate hiking

Bill Cara is one of the few wise old men who's words give me pause. I've learned a lot from him in a short time. One of my favorite new techniques from Bill's analysis playbook is the spread between the 3-month and the 30-year US Treasury bonds. Earlier this year Cara warned that the spread has narrowed from a comfortable 300 basis points to being closer to 200 basis points. Since then, I've watched the spread narrow to where it is today: 176 basis points. This is money flowing out of US equities and into the relative safety of bonds. But anyway, the real reason I'm posting is to discuss his latest writeup on fed tightening.

Here's the link to Bill's write-up on why the fed's hand is being forced on this rate hike campaign. Bill mentions that part of the idea behind higher interest rates is to discourage nonproductive speculation with higher margin interest rates. I am one of those speculators who will be affected by higher margin interest rates because they act like a tax for maintaining large positions (I am often maxed out on margin). I think it will affect the less effective traders the most because if they cannot outperform the margin rate, they cannot sustain highly leveraged positions for any significant stretch of time. This idea is definetely congruent with a contractionary period for equities because we have a harder time saddling our old positions with the most effective traders =)

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