By: Ronald D. Struck                                                               August 24, 1998

 

 RATES ARE GOING TO FALL A LOT MORE!

On June 16^th I wrote, “The U.S. has not yet felt the full impact of the weakness in Asia, but it will.”  “The Fed will become more accommodating and yields for short-term securities will decline, perhaps rapidly.”  “If… you have money that could be invested in two to five year maturities but delay in doing so, you could end up leaving a lot of money on the table.”  At the time, the 2-year treasury was trading around 5.49%, the 30-year at 5.65% and the Dow at 8665.

On July 20^th I wrote, “The problems facing Japan, Russia and Asia make those that we faced in the U.S. in the late 1980s/early 1990s pale in comparison.”  “It is highly unlikely that most political leaders will pursue policies that will address the fundamental problems.”  “Even if there are…they will not initiate them quickly enough to achieve the desired results.”  “…This will cause the current high level of consumer confidence to decline sharply.”  At the time, the 2-year was at 5.45%, the 30 years at 5.71%, and the Dow at 9295. 

What has the market done since these writings?  Both yields and equities have declined.  Today the 2-year treasury is at 5.2%, the 30-year at 5.5%, and the Dow at 8566.  Foreign economies, Russia especially, are getting weaker and weaker, and confidence in the financial markets, as measured by every equity index in the world, is in decline. 

Optimists are saying; there’s plenty of steam in the U.S. economy, look at the employment numbers, look at what’s happening in housing.  The pullback in the stock market just provides a great opportunity to pick-up attractive stock at bargain-basement prices.  With all this steam, interest rates can’t go much lower or we’ll have inflation. 

But, how can one be an optimist about the economy without believing in the efficient and timely performance of political leaders?  So, how are the world’s political leaders doing?  Let’s see, equity markets are in broad retreat throughout the world.  Countries are seeking trade advantages by devaluing their currencies against the dollar, causing the dollar price of commodities to deflate.  Countries are looking for IMF bailouts, but its solutions often exacerbate problems, and in any event, it’s broke.  And, in the U.S., apparently our government is about to close down again because it can’t pass a budget.  And, with the 30-year treasury trading at historic lows, the Fed is concerned about the inflationary impact of a steamed up economy and holding the Fed Funds rate at 5.5%, causing an inverted yield curve. 

For the sake of your fixed-income portfolio, keep your eyes on the ball and focus on the fundamentals:

-          Consumers are much better informed and smarter than many pundits think.  U.S. consumer confidence may already be wavering (the declining Dow average is a surrogate that supports this fact).  Watch for signs of changes in consumer confidence because, when it changes, it could nose-dive, quickly take the steam out of the U.S. economy, and exacerbate the worldwide economic problems. 

-          The equity markets may have sub-levels below what pundits are calling bargain-basement prices.  Watch for moves into these sub-levels, causing a flight to quality from equities into bonds. 

-          Today’s economic problems are unique and complex.  Traditional governmental actions will not solve them.  They will continue to worsen until leaders of vision take bold new steps.  Watch for actions, not words, which prove such leaders are in place.  Until then, the foreign economic turmoil will expand, increasing the movement of money into the safety of U.S. government bonds.

-          The Fed will ultimately recognize what the inverted yield curve is already telling it, the world economy is teetering, and the Fed Funds rate must be lowered.  When it does, short-term U.S. bond rates will plunge. 

On July 20^th, I wrote…”even though interest rates are already relatively low, I believe there is a very high probability that they are going to fall even further.”  They’ve fallen significantly since then, but they are going to fall even more through 1999.  A 4% 2-year and 5% 30-year are well within the cards.

 

 

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