Bond rates are still low! Get used to it.

by mickeykessler on February 1, 2011

in Kessler's Westwood Blog, Latest News

image001 Bond rates are still low! Get used to it.

NEW YORK (CNNMoney) — Long-term bond rates shot up dramatically at the end of last year. But the fixedincome market has been, dare I say it, boring so far in January.

Is that all about to change now that President Obama has given the strongest indication yet of the needto tackle the deficit in Tuesday’s State of the Union address?

The Federal Reserve, which concluded a two-day meeting Wednesday, also appears intent on buyingTreasury debt in an attempt to keep rates low. It left its key short-term rate near zero yet again andmade no significant change to other policies.

First and foremost, the renewed focus on getting the deficit under control should be a positive forbonds. A more manageable federal debt load would likely lead to a stronger dollar and less fear aboutinflation. That should push rates lower since bond prices and yields move in opposite directions.

“The stars may now be aligned on the deficit,” said Leslie Barbi, head of fixed income for RSInvestments in New York. “There should be some headway on that made in the first half of theyear. The reality of getting something done should lower rates because there may no longer be thisunbelievable supply of Treasuries out there.”

Still, there’s some skepticism about just how much the president and lawmakers will be able to getaccomplished. That could keep bond investors from buying too much debt.

Keep track of the bond market”The bond market has the impression that the president is serious about addressing debt levels. But there isn’t enough detail to really grab on to,” said Ray Humphrey, senior vice president at HartfordInvestment Management Co. in Hartford, Conn. “It’s one thing to talk the talk. Investors want thegovernment to walk the walk and actually cut spending.”

You also have to throw the Fed into the mix. Fed chair Ben Bernanke and the rest of his fellow merrypolicymakers committed in November to buy up to $600 billion in bonds through the end of June.

Although the central bank said at that time that it reserved the right to “adjust the program as needed”based on economic conditions, Barbi said she doubted the Fed would end QE2 prematurely.

0:00 /05:08The Fed’s inflation hawkShe argued that QE2 may no longer be as necessary as it was late last year now that there are signsof improvement in the economy. But job growth remains stagnant. So that is likely to keep the Fed frompulling the plug on QE2 prematurely.

“The Fed has painted itself into a corner. It has to wait a few more months to have some proofthat the unemployment rate has really come down. The Fed would look stupid if it changed thingsbefore that,” she said.

Now here is where things get muddled. The purpose of QE2 is to keep long-term rates low.However, the yield on the 10-year U.S. Treasury is now hovering around 3.4%. That’s up a lot from2.6% in early November.

But dubbing QE2 a failure may be a mistake. For one, a 10-year yield below 3.5% (or even 4% forthat matter) is still a relatively low rate by historical standards.

The 10-year was yielding above 5% as recently as the summer of 2007 — shortly before the creditcrisis and recession began in earnest. So rates could even creep up a bit more and not really beconsidered problematic.

All eyes on the FedAnthony Valeri, fixed income strategist with LPL Financial in San Diego, said he thinks that the 10-year will probably bounce around between 3% and 4% for the remainder of the year. He arguesthat rates might already be significantly higher if the Fed wasn’t stepping in as a buyer of lastresort.

“The question is, ‘What would rates be if QE2 was not in place?’ Bernanke doesn’t want yields tobe that much higher,” he said. “That’s why the Fed will keep stressing that inflation is low and thatthe job market is still sluggish. That’s a bond-market friendly statement.”

And as I pointed out in a column last week, China still has a voracious, albeit slightly smaller,appetite for U.S. Treasuries. Demand from foreign governments will also probably help keep rateslow.

What’s more, the economy is not roaring, it’s merely petering along. According to an exclusiveCNNMoney survey, economists are forecasting GDP growth of 3.5% for the fourth quarter. That’sgood, but not enough to make people forget just how far the economy plunged in 2008 and 2009.

Add that up and that probably means that rates will stay in a tight range for some time, no matterwhat the Fed, the president and Congress do.

“We’re not likely to see explosive growth for the economy coming out of this recession the way wehad in prior ones,” said Humphrey. “There will be low interest rates for a prolonged period.”

For inquiries and more information contact Steve Eckhoff of First Capital Mortgage at 310-470-8080 or Mickey Kessler of Coldwell Banker at 310-367-2322.

image001.png.scaled.500 Bond rates are still low! Get used to it.

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