Fed Rate Pledge May Send Investors Into Risk
By Margaret Collins and Alexis Leondis – Jan 26, 2012
The Federal Reserve is trying to help Americans by stimulating the economy with low interest rates. It may actually push some of them toward riskier investments for yield.
The Federal Open Market Committee said yesterday that economic conditions are likely to warrant “exceptionally low levels for the federal funds rate at least through late 2014.” The benchmark interest rate has remained near zero since December 2008 as the economy and housing market have struggled to recover.
That means U.S. investors starved for yield will have to continue their search for income by extending maturities or durations of their fixed-income holdings, or putting money in riskier, higher-yielding securities, said Dean Junkans, chief investment officer of Wells Fargo Advisors and Wells Fargo (WFC) Private Bank, which are units of Wells Fargo & Co.
“There’s not an easy answer for retirees,” said Junkans, who’s based in Minneapolis. “Don’t be lulled into the belief that buying intermediate Treasury-type products or strategies at these low, low interest levels are risk free.”
Treasuries rallied yesterday on the Fed’s rate pledge, pushing the five-year note yield to 0.79 percent. Yields were 1.99 percent on the 10-year note and 3.15 percent for the 30- year bonds.
“I wouldn’t get too cute, too tricky in this,” said Rex Macey, chief investment officer at Wilmington Trust, of taking on a lot of duration or maturity risk.
Rates May Rise
The risk of holding longer-term bonds is that interest rates may rise, even before 2014, and if that happens, investors may see the price of their bonds drop, said Richard Saperstein, managing director at HighTower Advisors’ Treasury Partners in New York. There’s a possible “Cinderella scenario,” in which the U.S. economy may strengthen and fears of Euro contagion diminish, causing a shift to equities from bonds and an increase in rates, he said.
Investors should consider trimming bonds in their portfolios that have maturities of 10 years to 30 years and remember that the Fed’s policy will continue to keep short-term rates anchored close to zero, he said.
Investments that offer higher yields than Treasuries such as high-yield debt, emerging-market debt or floating-rate notes will also appeal to investors as they expect rates to remain low for the next two years, said Macey of Wilmington Trust, a unit of M&T Bank Corp. (MTB), which oversees about $60 billion in assets.
Junk Bond Sales
The average daily volume of publicly traded speculative- grade bonds rose to $4.92 billion this month, a 74 percent increase from December, according to the Financial Industry Regulatory Authority’s bond-pricing system. High-yield bonds are rated below Baa3 by Moody’s Investors Service and lower than BBB- by Standard & Poor’s.
Sales of new junk bonds are accelerating at the fastest pace since September, and exchange-traded funds focused on the debt are growing at the fastest two-month pace since 2009.
Junkans of Wells Fargo said he’s advised clients to seek income in multiple assets, such as dividend-paying stocks, real estate investment trusts and master limited partnerships, rather than extending maturities.
“Retirees are tired of no return on their investments and that leads to problems because the con artists know that,” said Jack Herstein, assistant director of the Nebraska department of banking and finance and president of the North American Securities Administrators Association. “They know the elderly have most of the income and will make promises of high-yield investments that can’t miss.”
Senior investors may turn to structured products and loosely regulated private placements without understanding the terms and risks of the investments, Herstein said.
Fed Chairman Ben S. Bernanke said the central bank’s policy to help boost the economy can best help American savers.
“The savers in our economy are dependent on a healthy economy in order to get adequate returns,” Bernanke said at a news conference in Washington after a meeting of the Federal Open Market Committee yesterday. “If our economy is in really bad shape then they’re not going to get” good returns on their investments, he said.
Not Good News
Savers using low-risk investments such as money-market funds, savings accounts and certificates of deposit have been, and will continue to be, penalized by the Fed’s low interest rate policy, said Christopher Philips, senior analyst in the investment strategy group at Vanguard Group Inc.
“For those who are looking for safe, secure income, it’s not good news,” said Wilmington Trust’s Macey, who is based in Atlanta.
The national average rate on deposits, which includes checking, savings and money-market accounts, and CDs as long as five years, is 0.59 percent, according to Dan Geller, executive vice president of Market Rates Insight in San Anselmo, California. That’s the lowest since he started tracking the data in January 1990. Interest rates on deposits may reach zero within the next 12 months to 18 months if lending continues to be soft, he said.
A bright spot for borrowers is that the Fed’s pledge will likely further trim mortgage rates, which are linked to long- term government bond yields, and then keep them from rising soon, said Greg McBride, the senior financial analyst at Bankrate.com, a unit of Bankrate Inc. (RATE) The average rate for a 30- year mortgage rose to 3.98 percent in the week ended today from 3.88 percent, the lowest in records dating to 1971, Freddie Mac said in a statement.
Credit-card lenders, betting that their funding costs will remain low, also may boost or extend offers for zero-interest balance transfers, McBride said.
— With assistance from Joseph Ciolli and Caroline Salas Gage in New York. Editors: Rick Levinson, Christine Maurus.