News Column

St. Louis Post-Dispatch Jim Gallagher column

June 15, 2014

By Jim Gallagher, St. Louis Post-Dispatch

June 15--If you'd like to end up looking like a dummy, try forecasting interest rates. That will often do the trick.

Platoons of economists and bond analysts are wearing dunce caps today. They started the year predicting that rates would go higher. They went lower instead.

But the consensus among gurus remains that rates should go up from here. At Wells Fargo Advisors, for instance, chief macro strategist Gary Thayer sees the 10-year Treasury bond at 3.25 percent by New Year's Day, up from 2.6 percent on Friday.

Could the market oracles be right this time?

The answer is important for bond investors, because higher rates mean lower bond prices. It's also important for scaredy-cat savers who have been suffering from stingy interest rates on their bank CDs, and for people who may need a mortgage in months to come.

The predictions last fall were based on a rosy scenario for the U.S. economy -- moderate growth, plus a rising job count would raise demand for goods and borrowing. The Federal Reserve was tapering off its bond-buying, which was holding rates down.

Those predictions got walloped by the weather. The icy winter actually shrank the economy in the first quarter, although it's bouncing back nicely now.

But the gurus' biggest goof was miscalling Europe, where the European Central Bank is pushing down on both interest rates and the value of the euro. These days, money crosses seas in an instant. U.S. interest rates are higher than in Europe and Japan. So foreign money is flooding in and holding down American interest rates.

A U.S. Treasury bond competes with German and Japanese government bonds, which also bear nearly no default risk. The 10-year German bond yields 1.2 percent and the Japanese bond just 1 percent.

"The American bond seems like a steal," says Scott Colbert, who manages the $828 millionCommerce Bond Fund at Commerce Bank.

Inflation is a little higher in the U.S., which takes away some of the American yield advantage, but world bond investors clearly think the sweetest deals are in the U.S.

Since economists blew their last forecast, why do they still think rates are headed up?

Because they're optimists. U.S. economic growth has bounced back this spring. GDP is growing at a healthy 3.5 percent this quarter, according to economists surveyed by Bloomberg, and they expect a healthy 3.1 percent rate through the rest of the year. The jobs picture is steadily improving, and that should raise demand for products and for money to finance them.

The current betting is that the Federal Reserve will raise short-term interest rates sometime next year. But Fed officials will start talking about their plans much earlier, says Thayer, and that warning talk could cue rising rates in general.

That's the economic textbook scenario.

"You should take those textbooks and throw them in the trash can," says money manager Joe Terril. Terril, who runs $720 million at Terril & Co. in Sunset Hills, thinks we're in for a long stretch of low and stable rates.

The texts were written before globalization. "We've never had a world investment market like we have now," he said. American rates now depend more on what's happening elsewhere.

Persistent slow growth across the planet will mean low demand for borrowing from corporations wanting to expand, says Terril. Meanwhile, there's lots of money sloshing around.

"There is too much world capital chasing too few investments," he says, and that should hold rates down.

How should small investors react to all this?

Realize that nobody's smart enough to call rates. Very smart people often get it wrong. So, hang around in a good intermediate-maturity bond fund for the biggest part of your fixed-income investments, Colbert says.

They'll suffer some if rates rise, as Colbert expects they will. A typical intermediate fund will lose about 5 percent of its share price if rates rise 1 percent. But the interest yield (think about 3 percent on an intermediate corporate bond fund) should erase much of the pain.

If you're convinced rates will rise, consider going short-term. A short-term bond fund will lose only about 2 percent of its value with a 1 percent rate rise, eased by a 1.9 percent yield on a no-load corporate fund.

At Morningstar, the fund-rating company, analyst Samuel Lee thinks some online bank CDs offer better value than short-term funds. Last week, Brentwood-based Everbank was offering 2.3 percent on a five-year CD, as was Synchrony Bank, a unit of General Electric.

You can't lose money if you hold them to maturity, no matter what interest rates do, but early-withdrawal penalties can be heavy -- 2 1/2 years of interest in the case of Everbank.

"There is no better deal out there in fixed income," Lee wrote in a report last week.

Jim Gallagher is a reporter at the Post-Dispatch


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Source: St. Louis Post-Dispatch (MO)

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