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How the Bond Markets React 02.01.05
Another Meeting, Another Increase
The Federal Open Market Committee meets today for another two day meeting accompanied by the much predicted "measured" increase in short term, over night interest rates. A quarter point increase would be the sixth in a row raising rates to 2.5%.
As usual, it isn't so much the increase but the thinking behind the move. This increase comes ahead of the January job numbers that are expected to come in at 200,000. I expect less than that consensus numbers because the slowing GDP and minimual inflation has not allowed industries to fix prices higher without consolidation. Companies are not growing through product prices but instead through merger and acquisituions. While these are good for certain groups, the moves by these industries tends to eliminate jobs in the long run, not increase employment.
Corporate CEOs understand that this will be a slow growth year and have adjusted their hiring and thinking to accomodate a year of weaker GDP growth. The last quarter of last year showed slower growth beginning even as the stock market rallied. 3.1% GDP does not preclude a significant change in how these coprorate chiefs operate. Corporate marriages do not signify any change in thinking. And even more imnportantly, these companies are flush with cash reserves that they seem to sitting on.
Some of you have asked about the ratings on high yield investments, specifically how they are determined. The Lehman Brothers U.S. Credit Index is the most widely used index of corpoarte bond health. Recently, the rules were changed in how these offerings were indexed. The Index now uses the middle rating of three separate ratings firms to determine the weighting of their index. Those ratings companies include Moody's, Standard & Poor's and Fitch Ratings. From these three ratings, a company will need at least two investment grade ratings to find themselves offered as a Lehman indexed company.
Missing the index could have a company's bond rating reduced to junk status or high yield risk. Fixed income investors view these offerings as a wholly different investment class.
As equities go down, the investment in the 10-year Treasury grows. As investors look for a safe haven, the price on the note rises and the yield falls. Confidence in the strength of the economy is beginning to wane as the deficits are likely to grow as the President begins his push to reform Social Security (estimated cost $1.3 trillion) and change the tax code.
One final note. Consumer rates have remained low even as the short term rates have increased. Mortgage rates have fallen while short term loans, usually around 24 months, have only increased 0.04%. This is largely due to a very large supply of available cash. Along with a weakening economy, increased competition between lenders, and the ever steady appetite for spending, expect the low interest credit cycle to prolong itself until mid-year.
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