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Greenspan's 'Conundrum' Can Teach a Lesson
Long-term Rates Move Opposite of Expectation
By Jeff Hussey, Portfolio Manager
Russell Investment Group
June 10, 2005
The following article has been issued by our parent Frank Russell Company in Tacoma, Washington and is referring specifically to the US market unless otherwise noted.
What US Federal Reserve Board chairman Alan Greenspan called a 'conundrum' more than three months ago remains a poser.
Why has the pressure the US Fed is exerting on short-term rates not translated into increases in long-term rates? Over the past year, the US Federal Reserve has raised short-term rates from 1% to 3% but yields on 10-year bonds have fallen. So much so that by May 31, the 10-year Treasury had fallen from the 4.61 it yielded at the end of June 2004 to fractionally above 4%.
The obvious answer is it's a matter of supply and demand. More investors are buying than selling Treasury bonds. The unknown factor is why.
Theories:
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- Pension funds feel obliged to buy longer term bonds to protect their capital for future needs. The recent default by the United Airlines pension fund might have woken up other corporations with large pension funds to the possibility they might face similar problems. Buying bonds may help to protect their assets.
- Investors in bonds might believe the economy has slowed, inflationary prospects are receding and the US Federal Reserve will stop increasing rates soon, a move that would benefit bonds. They are buying bonds now, in advance.
- Hedge fund managers, bruised in recent months, could be moving into Treasury bonds as a safe haven to help them retain their track records.
- Foreign investors could be buying US bonds in significant quantities.
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Whatever the reasons, the move runs counter to most analysts' expectations. They advised clients a year ago to move out of long-term bonds as the US Fed raised short-term rates.
Instead, in-depth diversification may prepare your portfolio for a broader range of scenarios in an unpredictable market.
This is a publication of Russell Investments Canada Limited. Nothing in this publication is intended to constitute legal, tax, securities, or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. The contents in this publication are intended for general information purposes only and should not be acted upon without obtaining specific legal, tax, and investment advice from an investment professional concerning your own situation and any specific investment questions you may have.
The information, including any opinion, is based upon various sources we believe to be reliable but its accuracy cannot be guaranteed. It is for information only, is subject to change at any time, and does not constitute an offer or solicitation to buy or sell securities referred to.
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