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How the Bond Markets React 01.11.05
Ring Tone
It was only six months ago that the short term interest rates were 1%. Fixed income investors were worried at the beginning of last year, much the way they are now, that those rates would rise. What they did not anticipate was the time it took for Fed chairman Alan Greenspan to begin those increases. Now at one and a quarter percent higher and poised to go higher, should bond traders be worried? Absolutely.
For bulls in this market, the hope that job creation accompanies wage increases and inflation will be moderate seems to be so much wishful thinking. Recent numbers suggest otherwise. Job creation did see some growth in the last month of the year but failed to give back what was lost in terms of real wages and real employment in manufacturing. These modest increases, done mostly in fits and jumps were not supported by any real wage growth - although spending, bless those consumer's pointed little heads, maintained its pace - with December's number, released last Friday showing only a 0.01% improvement in available cash.
Fixed income investors recognize problems when they see them and these issues seem to be piling up like so much flotsam against the dam. Between February and April, the Fed will meet again, Greenspan will visit Congress for his semi-annual reports, and economic data that is likely to show less job creation this year - last year provided only an average of 186,000 jobs per month when break even was a cool quarter of a million - all lead investors to expect higher short term rates.
The Fed minutes, released last week as well from their December meeting, told tales of impending worry among the nation's top bankers. Those concerns, not present in the official statement released after the meeting, point toward inflation worries that bond investors see as a sign that rates could top 4% this year and may do so in a hurry. Inflation is predicted to rise from the current 2% to 2.6%.
That leaves fixed income investors with precious little in the way of choices. One would be a bet on long term securities outperforming the short ones. Others include ignoring the credit risk of some corporate offerings in search of higher yields, although the spread, the comparable distance between similar Treasuries of like duration could increase. This would add unwelcome risk to many portfolios. The other option would be the purchase of mortgage backed securities which would have the less desirous effect of low volatility.
If growth slows however and we predict that it will not be much better than 3% this year, some even venture to say it will be less than that; if employment growth continues to languish; if inflation remains tame in the face of rising commodities; then the long term bets against the yield curve will pay off. But those are a lot of ifs and each is in a position to limit pressure on rising rates.
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