Bias ... Yes .. ?
Investors May Have Long Wait for a Neutral Fed: Rates of Return
By Al Yoon
New York, Sept. 29 (Bloomberg) -- Bond investors looking toward next week's Federal Reserve meeting for a hint that the central bank's series of interest-rate rises is over may be disappointed, a Bloomberg poll of Wall Street firms suggests.
Most of the 29 primary bond dealers that trade directly with the Fed predict policy-makers will maintain a leaning toward higher interest rates, using language employed at other meetings this year to express concern that risks of accelerating inflation are still present.
Should those predictions come true, Treasuries probably won't add to gains that have already grown to more than 9 percent for debt due in 10 years or more, said David Brownlee, head of fixed- income at Sentinel Advisors in Montpelier, Vermont.
``Until you get the perception that the Fed is going to remove the bias, and potentially cut rates, it's hard to see Treasuries do much better,'' said Brownlee, who is keeping most of his managed assets in corporate bonds for better income. That's especially true with market rates so far below the Fed's 6.5 percent target, he said.
The Fed next meets on Tuesday, when policy-makers are expected to leave the target rate for overnight bank lending unchanged for a fifth month at 6.5 percent. Only two of the primary dealers polled said the Fed may adopt a neutral stance toward the direction of interest rates, which would be the first step toward an official cut in borrowing costs.
Including a half-point rate rise in May, Fed officials have lifted interest rates by 1.75 percentage points since June 1999 in a bid to cool growth to a pace that won't fuel faster inflation, yet won't stall the economy's record expansion.
Priced In
At 5.97 percent, the current two-year note yield shows some investors are betting the Fed will suggest a rate cut may be just as likely as an increase in the months ahead, Brownlee said. Futures also indicate some investors predict the Fed's next policy move will be to lower rates. The fed funds futures contract for March dropped 3 basis points today to 6.385 percent, down from 6.535 percent earlier this month.
That leaves the market vulnerable to a sell-off on a statement that's as cautious as the last, Brownlee said.
In August, after noting that the economy is cooling and inflation-busting productivity continues to build, the Fed said it remained ``concerned about the risk of a continuing gap between the growth of demand and potential supply at a time when the utilization of the pool of available workers remains at an unusually high level.''
Consumer inflation is already on the rise. Prices on goods and services rose 3.5 percent in the eight months through August, up from a 2.3 percent gain in the prior period a year ago.
Filtering Through
Because most of that rise reflects higher energy prices, many economists and bond investors look instead to the ``core'' rate that excludes the volatile food and energy components. That's crept higher, too, rising 2.7 percent in the first eight months of the year, compared with a 1.5 percent gain in the year-ago period.
``Rising shelter costs as well as higher energy prices will begin to feed into the core index,'' which would erode the value of bonds' fixed returns, said Ian Morris, chief economist at HSBC Securities (USA) Inc. He expects the 10-year note yield to rise to 6.2 percent by year-end, up from 5.78 percent.
HSBC is among three dealers that expect a quarter-point rate increase by December.
Rising Treasury yields typically mean higher home mortgage rates, which for an average 30-year fixed-rate loan have stayed below 8 percent for a seventh week in a row, according to Freddie Mac, a mortgage financier. At 7.9 percent, the average rate is down from a five-year high of 8.64 percent in May.
Wild Card
There is one wild card that may end up helping Treasuries, and even change Fed policy: the stock market. A sustained drop in the major U.S. indexes may buoy bonds as investors seek a haven in fixed-income, said Bruce Alston, who invests $1.5 billion at Value Line Asset Management.
The Nasdaq Composite Index has lost more than 12 percent this month, and fell 9 percent on the year.
``We may see the beginning of a large asset allocation trade from equities to bonds, as the equity market grapples with a softer economy and its corrosive impact on earnings,'' said Alston, who manages the bond side of the firm's balanced funds.
The most-active 10-year Treasury note rose about 3/8 point, or $3.75 per $1,000 face amount, on the week as its yield dropped 6 basis points. Much of the gains came at the expense of the stock market, which today featured a loss of more than 2 percent on the Nasdaq Composite Index.
Stance Shift?
The survey finds a third of the dealers expect the Fed to signal it's more open to the idea of lower rates by December as the economy cools from the 5.6 percent pace registered in the second quarter. A faltering stock market -- which could brake consumer spending -- may be all the Fed needs to wean itself off of its unofficial slant toward higher rates, said John Ryding, senior economist at Bear, Stearns & Co.
For all the risks to price indexes, bond bulls note inflation isn't rising at an alarming pace. The latest reports showed a 0.1 percent drop in consumer prices, a 0.2 percent decline in producer prices and slower-than-expected growth in retail sales in August. That built on other economic phenomena that should help contain inflationary pressures, such as three straight months of slower job creation.
An 18 percent drop in the price of oil since Sept. 20 also helped alleviate concerns that companies would raise prices on a wide variety of goods.
The results of the 29 primary dealer survey follows:
FED FUNDS STATED FED FUNDS STATED FIRM OCT. 3 RISK? YR-END RISK?
ABN Amro, Inc. 6.5 inflation 6.5 inflation Banc of America Secs. 6.5 inflation 6.5 inflation Banc One Capital Markets 6.5 inflation 6.5 inflation Barclays Capital Inc. 6.5 inflation 6.5 inflation Bear Stearns & Co. 6.5 neutral/infl. 6.5 neutral Chase Securities Inc. 6.5 inflation 6.5 inflation CIBC World Markets 6.5 inflation 6.75 inflation Credit Suisse First Boston 6.5 inflation 6.5 neutral/infl. Daiwa Securities America 6.5 inflation 6.5 inflation Deutsche Bank Securities 6.5 inflation 6.5 inflation Donaldson, Lufkin & Jenrette6.5 inflation 6.5 inflation Dresdner Kleinwort Benson 6.5 inflation 6.5 inflation Fuji Securities, Inc. 6.5 neutral 6.5 neutral Goldman, Sachs & Co. 6.5 inflation 6.5 inflation Greenwich Capital Markets 6.5 inflation 6.5 inflation HSBC Securities (USA) Inc. 6.5 inflation 6.75 inflation J.P. Morgan Securities Inc. 6.5 inflation 6.5 inflation Lehman Brothers Inc. 6.5 inflation 6.5 inflation Merrill Lynch & Co. 6.5 inflation 6.5 neutral Morgan Stanley Dean Witter 6.5 inflation 6.5 inflation Nesbitt Burns Securities 6.5 inflation 6.5 neutral Nomura Securities Intl 6.5 inflation 6.5 neutral PaineWebber Inc. 6.5 inflation 6.5 neutral BNP Paribas 6.5 inflation 6.5 neutral Prudential Securities Inc. 6.5 inflation 6.75 inflation Salomon Smith Barney Inc. 6.5 inflation 6.5 neutral S.G. Cowen Securities 6.5 inflation 6.5 inflation UBS Warburg LLC 6.5 inflation 6.5 inflation Zions First National Bank 6.5 inflation 6.5 inflation |
