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Strategies & Market Trends : Booms, Busts, and Recoveries -- Ignore unavailable to you. Want to Upgrade?

To: TobagoJack who wrote (42018)	11/24/2003 5:17:47 AM
From: elmatador	Respond to of 74559

Don't Be Lulled: Interest Rates Could Be Poised to Leap By JONATHAN FUERBRINGER Published: November 23, 2003 nytimes.com WHEN thinking of interest rates, think of a coiled spring. That tells you how quickly Treasury yields could rise, driving down prices across the fixed-income market. Rates have risen well above the 45-year lows they reached in June, when the Treasury's 10-year note was at 3.11 percent. But they haven't gone up as much as might be expected. Now at 4.16 percent, the yield is well below the 2003 high of 4.60 percent, reached on Sept. 2. Some forecasters had predicted that the yield would reach 5 percent when the economy got back on track. Well, the economy is expanding rapidly. It grew at a 7.2 percent annual rate in the third quarter and is forecast to move ahead at a pace of 4 to 5 percent this quarter. Rising expectations of inflation should also be pushing rates higher. Since the end of August, the expected inflation rate derived from the Treasury's 10-year inflation-protected security has climbed to 2.25 percent, from 1.98 percent. Why have interest-rate increases been slow? One reason is the current "deal of the day" in the Treasury market. But because traders' inclinations can change suddenly - and the economic forces for higher rates are already in place - the rate spring is coiled tightly. The deal of the day is called a carry trade. It is simple. Institutional investors, like banks, borrow money for the short term at a very low interest rate and use the cash to buy a longer-term security paying a higher interest rate. Then they pocket the difference. For example, banks can borrow at the federal funds rate, about 1 percent, and use the money to buy two-year Treasury notes, which yield 1.82 percent, or three-year notes, which yield 2.35 percent. In normal circumstances, this would be a risky strategy, because a sudden upturn in short-term interest rates could quickly produce a loss. But Federal Reserve policy makers have reduced the risk by promising to keep their target for the federal funds rate at 1 percent for some time. The fact that shorter-term rates have been held back - the 1.85 percent yield on the two-year note is below its September high of 2.04 percent - has also helped restrain the rise in the Treasury's 10-year note, analysts said. "Short-term rates act as an anchor for longer-term rates," said Ward McCarthy, a managing director at Stone & McCarthy Research in Princeton, N.J. Rates had been rising, he said, "until we got reassurances from Fed officials that they would not pull the trigger quickly'' on a rate increase. Futures contracts on the federal funds rate now show that many investors don't expect a Fed rate increase until early May, and some forecasters say the Fed will hold fire even longer. George Strickland of Thornburg Investment Management, which manages about $3.6 billion in fixed-income assets, argues that a ladder strategy - holding bonds in a carefully planned series of maturities - is a good defense against a spring back in interest rates. Generally, Thornburg's portfolios are divided equally into maturities from 1 to 10 years. Those of relatively short terms suffer less of a price loss as rates climb. And after the first year, if rates have leveled off, one-tenth of the portfolio turns back into cash that can be reinvested at higher rates. THIS is a conservative approach, and it can be a loser in the first year if rates are rising, but it can result in a moderate positive return if rates then level off. Mr. Strickland is being even more cautious in the $1.4 billion Limited Term Municipal Fund National Portfolio which he runs, by shortening his ladder to about eight years. The fund's total return, year to date through Thursday, is 2.99 percent, about three-quarters of a percentage point better than his competitors, according to Morningstar. "The coils are compressed," he said, referring to interest rates. "So it's a good time to be cautious."