Treasury Puts Up; Will the Market Shut Up?

ETF traders who believe Treasury bond prices will fall and interest rates will rise can put their money where their mouths are starting today. The Treasury Department is set to borrow $235 billion in the week finishing next Thursday.

The largest auction previously saw some volatility but eventual digestion of the bonds. In May, the government issued $100 billion worth of bonds and ProShares UltraShort 20+ Year Treasury (TBT - commentary - Trade Now) gained 6.7% from the day before the auction to the second day, but fell on the third day and was at a loss to investors who held on for the day after the auctions were complete.

Conditions are ripe for a volatile auction period because bond prices are already falling in the face of advancing equities. Wild cards include a move in the U.S. dollar. Higher interest rates could draw capital into the U.S. and be bullish for the U.S. dollar, but there's a risk that the Federal Reserve may step in to purchase the bonds if the auctions appear to falter.

That could be good news for PowerShares U.S. Dollar Bearish Fund (UDN - commentary - Trade Now) and precious metal ETFs such as iShares COMEX Gold (IAU - commentary - Trade Now) and iShares Silver Trust (SLV - commentary - Trade Now) because traders are likely to pile into this popular trade. Either way, these funds may rally because many investors may be convinced that higher interest rates signal a weak dollar and it may take the pain of seeing their positions reversed over time to teach them a lesson.

Higher interest rates are deflationary, bullish for the dollar and bearish for commodities. Lower rates are bearish for the greenback and, if triggered by quantitative easing, they could be extremely bullish for precious metals.

It makes sense if you think ahead a few months. A failed auction, or successful one at much higher rates, means the government will have to cut back on its spending plans, mortgage rates will jump (killing any housing recovery) and corporate borrowing rates will rise. A successful auction means the government can spend away, people can borrow to buy homes and corporations can roll their debt.

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At the time of publication, Dion was long IAU and UDN.

Don Dion is the publisher of the Fidelity Independent Adviser family of newsletters, which provides to a broad range of investors his commentary on the financial markets, with a specific emphasis on mutual funds and exchange-traded funds. With more than 100,000 subscribers in the U.S. and 29 other countries, Fidelity Independent Adviser publishes six monthly newsletters and three weekly newsletters. Its flagship publication, Fidelity Independent Adviser, has been published monthly for 11 years and reaches 40,000 subscribers.

Dion is also president and founder of Dion Money Management, a fee-based investment advisory firm to affluent individuals, families and nonprofit organizations, where he is responsible for setting investment policy, creating custom portfolios and overseeing the performance of client accounts. Founded in 1996 and based in Williamstown, Mass., Dion Money Management manages assets for clients in 49 states and 11 countries. Dion is a licensed attorney in Massachusetts and Maine and has more than 25 years' experience working in the financial markets, having founded and run two publicly traded companies before establishing Dion Money Management.