WHY THE FED IS OVERREACTING
AND WHAT IT MEANS TO YOU
Last year investors were concerned that the Fed wasnāt aggressive
enough in slowing the economy. They feared that Alan Greenspanās
gradual approach to raising short-term rates would be too little,
too late.
In our column at the time, we saw it differently. We said the Fed
would push too hard. We based our opinion on the fact that it takes
about 12 to 18 months for Fed moves to affect the economy. We were
concerned that Greenspan would continue to raise rates even after
the economy began cooling off.
Dj vu All Over Again
At the risk of suggesting that Alan Greenspan might be something
less than omnipotent, we think he is overdoing it again.
It appears, from recent Fed action, that Greenspan is aware of his
prior mistakes and is overreacting to them. The Fed has eased short-term
rates from 6.50%, where they started the year, to 4.00% in less
than five months, without any indication of how previous rate cuts
will affect the economy.
The feedback from the Treasury bond market seems to be:"Proceed
with caution!"
Mr. Greenspan is well aware that while the Fed has pushed down short
rates, 10-year and 30-year bond yields have recently begun to rise.
If this trend continues, the Fed will be forced to reevaluate its
easing policy.
Since business and the economy actually run on long-term interest
rates, higher long rates will neutralize any benefit achieved by
reducing short-term rates.
Ironically, higher long-term rates pose a threat to the two sectors
of the economy that have displayed the most strength: housing and
consumer spending.
If corporations are forced to pay more for long-term financing,
anemic earnings and unemployment will be further aggravated, pushing
economic recovery further into the future.
Keep Your Eye On The Ball
What does this mean to you as a long-term investor?
Very little.
Thus far the rise in Treasury bond yields has had very little influence
on municipal bonds. Since we expect the up-tick in Treasury yields
to be short lived due to continued weakness in the economy, we encourage
tax-free bond investors to take advantage of the fact that municipal
bond yields are very attractive when compared to taxable fixed-income
investments.
Remember these basic principles:
- Purchase investment-grade bonds to ensure a reliable stream
of income.
- Maximize income on each purchase. There is no benefit to having
bonds mature every year.
- Protect your income. Be certain that your bonds cannot be called
too early.
- Diversify your holdings.
- Buy bonds in denominations of 15,000 or more to enhance marketability.
Tax-free bonds have certain characteristics and nuances that distinguish
them from other types of securities. As always, we encourage you
to discuss your bond purchases with a tax-free bond specialist or
e-mail us with any questions.
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