QE3 and Shorting Bonds

With the third round of quantitative easing set to begin, there are some people saying it is time to short bonds.  In fact, many of these people are libertarians and Austrian school economists.  They believe that a rise in interest rates is inevitable, as the Fed creates more money out of thin air.

If you look on the right side of my blog page, I link to Charles Goyette's book called The Dollar Meltdown.  I highly recommend the book.  However, there is one point that I have been critical on with regards to Goyette's suggestions.  He suggests shorting bonds, predicting that interest rates will rise.  He actually predicted this a few years ago and he has been completely wrong.  I don't think it is a good idea to compete with the Federal Reserve, the biggest bond buyer of them all.

This doesn't change with QE3.  While the Fed will buy more in the way of mortgage-backed securities, it also indicated that it will roll over expiring government debt.  While I agree with Goyette and others that interest rates will eventually rise, I have no idea when and I don't think it is wise to assume that it will be sometime really soon.

So when will be the right time to short bonds?

Bonds go down in value when interest rates go up.  As long as the Fed is buying debt and price inflation remains relatively low, then I see no reason why rates would go up.  Interest rates are only likely to go up significantly when the Fed stops with its so-called quantitative easing.  When the Fed stops buying government debt, then rates are more likely to rise without the support.  And we can only rely on the Fed to stop creating new money out of thin air because of the threat of high price inflation.  The Fed doesn't see price inflation as a threat right now, so it is creating money to bail out the banks and to supposedly stimulate the economy.

So until we see a pickup in the government's price inflation numbers, then I don't see any significant rise in interest rates taking place.  Price inflation will be the canary in the coal mine for interest rates, not the other way around.

So what would be the point of shorting bonds right now?  You could be waiting for a while before it starts to pay off.  In the short-term, you could easily lose money on this bet.

If you are going to speculate right now, why not buy something that does well with higher inflation?  Higher inflation is much more likely to occur before higher interest rates.  Therefore, for speculation, you should be buying hard assets like precious metals, mining stocks, oil stocks, real estate, etc.  These will all benefit from a depreciating dollar.

In conclusion, I don't think now is the time to short the bond market, particularly while the Fed is engaged in quantitative easing that hasn't yet produced high price inflation.  There may be a good time in the future to short bonds, but that will not be until we see higher price inflation.