The markets may be stuttering…with the euro suffering in overnight trading and stock indices down over a percent at today’s open…but a continued rally still seems the foregone conclusion du jour. We’re not necessarily going to question it.

Despite a few brief months of rational behavior last year, the markets are given to obeying only their own reality. Something that Cornelius Luca – Editor of The Money Trader – picked up on last week…

“The U.S. jobless data was worse than expected,” he said in reaction to last week’s unemployment news…

“The unemployment rate climbed to 8.9% in April, the highest since late 1983. That was as forecast. More importantly, if we include laid-off workers who have given up looking for new jobs or have settled for part-time work, then the unemployment rate would have been 15.8% in April! And the nonfarm payrolls were bad in April and MUCH worse in the previous three months due to massive revisions!”

“But still, the DJI is marching higher! And the European and commodity currencies are marching higher as well. Even the GBP, which was battered on Thursday, is recovering.”

“So, the U.S. Dollar should remain under pressure through the end of May. Any bounce early next week should be used to go short at better levels.”

But even if you’re using this heady rally to lock in some nice, quick gains…then there’s one particular asset you should be watching like a hawk…

Ten-Year Treasuries: A Rally-Stopper

You see, the housing bubble remains a ticking time bomb.

Mainly because – as you can see in the chart below – there are still tens of billions worth of mortgages waiting to reset. When these loans reset, they click over to a new interest rate and payment, depending on prevailing market rates.

And as we all remember from the subprime blowout in 2007/8, significantly higher mortgage rates can lead to a bloodbath on these loans.

Back in 2007 – when few saw this coming – that eventually led to a full-blown market crash, insolvent banks, a credit freeze, US$14 trillion in bailout spending, and a flight to safety like almost nothing we’ve seen in living memory.

Now, that mortgage implosion threatens to repeat itself. Why?

Well, you may or may not know that ten-year Treasuries serve as a kind of benchmark for determining mortgage rates. It makes sense…Treasuries are seen as one of the safest investments out there. So if Treasury rates start to rise, then you should be charging more for mortgages and other types of loans as well.

And that’s exactly why the Fed’s focusing so much energy on keeping Treasury yields as low as possible. As long as these mortgages reset at all-time lows, the threat of Option ARM mortgages going “subprime” is minimized.

But it’s one big Catch 22…

If Ben keeps Treasury yields low – in turn keeping mortgage rates low – then he can minimize the damage caused by the whole universe of Adjustable Rate mortgages. If he can do that, he can convince investors that it’s safe to get back in the water…to start investing again.

But if he succeeds there, then money comes flying out of Treasuries…driving prices down and yields up (exactly what we’ve seen since the rally started in March.). If those yields reach high enough, then we have another mortgage crisis on our hands.

That’s why Ben broke out the “Quantitative Easing” in March. Essentially so that he could have his cake and eat it too. But as you can see in the chart below, QE – as it’s called – isn’t quite having the desired effect.

Rates Creeping Up On Rally

Knowing is Half the Battle

So even if the rally continues – and it looks like smooth sailing on the horizon – you should be keeping a close eye on Treasury bonds. Simply put; Treasury yields over the coming months and years will determine whether we see another mortgage crisis in the near future.

What’s more, it won’t necessarily take another major mortgage crisis to push the markets back into a decline, “We’ve got a heavily leveraged economy that’s still in the process of unwinding credit and toxic securities that’s now facing a serious threat from rapidly rising longer-term interest rates,” our Investment Director, Eric Roseman, surmises, “This is not a normal bear market. Sharply higher rates are now in the process of derailing this fragile bear market bounce.”

But there could also be some opportunity in today’s Treasury prices…

“Though I’m certainly bearish on Treasury bonds, especially long-term T-bonds,” Eric goes on, “I’m starting to consider short-term Treasury paper up to five years. This segment of the yield curve offers yields up to 2.16% and selling around $98, or a modest 2% discount to par. Six months ago prices were rich and yields barely 1.5%.”

“In a world that’s gone hog-crazy for risk following the worst crash since 1937, I find myself hunting for conservative investments that pay regular dividends or income. The big decline in Treasury bonds should be viewed as an opportunity to park some money ahead of the next shock later this summer or fall. In that event, yields will come crashing down again and T-bonds will rally.”

Yours in Personal Sovereignty,
Matthew Collins

Source: Keep an Eye on This ‘Rally-Stopper’…

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