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Interest Rates – Increase or Flat?

Published on June 25, 2008

Interest Rates – Increase or Flat?

June 25, 2008

There are two major economic indicators due today. Durable good order at 8:30am US EST and of course the FOMC announcement at 2:15pm. Markets may not move as much in the morning but expect the big move around 2:15pm to 2:30pm. Implied volatility of the July options will rise before falling back after the announcement. There is lot of uncertainty whether or not Fed is going to increase interest rates.

Let’s assume two scenarios. One in which Uncle Ben leaves rates as it is and another one in which case Dr Ben is not happy with the inflation figures and decides to increase interest rates (hiding Food and Oil doesn’t really work now as Oil is in the limelight in every news paper). He is stuck in a very delicate situation. Raise rates and economy falls into recession “officially” and don’t cut the rates then commodities, metal, and oil all surge to new highs.

What to do? My best guess is that rates will remain unchanged at least for this meeting.

For the first scenario, markets may remain where those are currently. There may be little bit of uncertainty, initial rallies and then dust will settle. I, in that case, shall be positioning for the commodities rise. If however, scenario #b happens then I think we’ll see selling. Dow specifically is sitting very close to 52wks low and all it would take is a “rate hike’ to send it lower then that level. And if that happens, we may even see increased selling pressure.

Put diagonals for bearish scenario may be good as implied volatility will increase and the put value will increase with the falling prices thus maximizing your gains from the fall. if however, you decide for the bullish scenario, credit spreads may be a good idea as IVs will fall after the announcement and theta plus delta will work in your favor.

Ignore what Mr Buffett says at your peril. The legendry investor warned global investors to be cautious of China stocks back in October’07 and guess what; china markets are nearly 50% down since then. You may argue that it’s all retrospect. Then, let’s get ready for what Mr Buffett mentioned sometime back-

Buffett offered to bet any taker $1 million that over 10 years and after fees, the performance of an S&P index fund would beat 10 hedge funds that any opponent might choose.

Wow, that’s quite a bold prediction of the financial market’s future. Protégé has placed its bet on five funds of hedge funds – specifically, the averaged returns that those vehicles deliver net of all fees, costs, and expenses. Of course the funds list is not disclosed.

It’s between Buffett (not Berkshire) and Protégé (the firm, not its funds). And there’s serious money at stake. Each side put up roughly $320,000. The total funds of about $640,000 were used to buy a zero-coupon Treasury bond that will be worth $1 million at the bet’s conclusion. That $1 million will then go to charity. If Protégé wins, it has asked that the money be given to Absolute Return for Kids (ARK), an international philanthropy based in London. If Buffett wins, the intended recipient is Girls Inc. of Omaha, whose board includes his daughter, Susan Buffett.

So it seems, if you were to go with what Mr Buffet says that index funding will probably be the best approach for next decade.

Whatever your choose, expect turbulance today and in many ways it may also be one of the deciding days,

Trade carefully, Trade profitably, OP

2 Comments

  • Avatar Steve says:

    Couldn’t agree with you more on the Fed holding things flat. If we focus on just the core rate CPI it shows growth of 0.0% to 0.2% for the last few months – this is hardly inflationary growth.

    While oil, food, and other commodity prices are booming, a tighetning of the Fed’s policy will have little impact of flooding in the midwest and global oil prices.

  • […] except the gold which I was expecting to happen yesterday. It was just a day later. Recall in my post yesterday, i mentioned two scenarios and my bias. Raise rates and economy falls into recession […]

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