Greenspan Keeps Playing Sphinx on Interest Rates
Dear Alan Greenspan: Are you or are you not planning to lower interest rates further in the months ahead?
Forty or 50 million savers and investors would like to know. Because yields on short-term investments are looking really lousy, and if they get any lousier, a lot more people will want to buy longer-term bonds.
Tuesday on Capitol Hill, the Federal Reserve chairman continued to play the Sphinx, spinning riddles for answers to interest rate questions. Like this answer from his testimony:
“The uncertainties in the current situation are great, and the risks of making policy mistakes are high.”
OK, that’s dandy. But what about those rates?
For the most part, Greenspan indicated Tuesday that the Fed didn’t feel obligated to cut interest rates again . . . but that could change.
The truth is, every Fed chairman since the time of Moses has played the Riddler. You can’t get a straight answer about rates--partly because the Fed usually doesn’t want to telegraph its intent and partly because the Fed just doesn’t know whether its stance on rates will change dramatically two days from now.
If Iraq surrenders tomorrow, consumer confidence rebounds and the economy starts to grow again, chances are rates have seen their lows. But the longer the war drags on, many experts believe that Greenspan & Co. will have little choice but to continue to prop up the economy with lower short-term interest rates.
In fact, some experts look at the results of the Fed’s handiwork so far--a drop of 1.5 percentage points in short-term rates since last July--and say it has done nothing for the economy. The message, say these Fed critics, is that the financial system is in very bad shape, consumers are shell-shocked and it’s going to take far bigger dose of Fed leniency to get things moving again. And that’s with or without a long war.
“It’s very clear that, as of right now, the Fed is not getting the job done,” argues Lacy Hunt, chief U.S. economist for the Hongkong Bank group in New York.
Hunt notes that long-term interest rates, especially on bonds of lower-quality companies, haven’t come down much since last fall. U.S. banks, Greenspan admitted Tuesday, aren’t lending like they should, because they’re trying to protect themselves and rebuild their capital. So despite the Fed’s efforts to ease the credit crunch, money still is tight while the recession continues to pinch--a bad combo.
Robert Brusca, economist at Nikko Securities in New York, believes that Greenspan has painted himself into a corner. The Fed chief on Tuesday told Congress not to raise taxes to finance the Iraq war, while at the same time he warned lawmakers not to change the federal budget deficit-reduction agreement reached a few months ago. Brusca says that leaves the Fed in the position of having to save Uncle Sam’s fiscal neck by keeping interest rates moving down--especially as the Treasury goes to sell billions of dollars in bonds in the first week of February.
“It seems to me Mr. Greenspan has put most of the burden of this economy on the Fed’s shoulders now,” Brusca says. While some analysts say there’s a growing risk that rates could rise in the months ahead if the economy turns, Brusca believes that “all of the risk here is that rates will end up being lower , not higher.”
For savers and investors, here’s the score:
* Last July, the yield on 30-year Treasury bonds was only about 0.5 percentage points above rates on three-month T-bills.
* Now, the 30-year bond yield is at 8.25%, while three-month T-bills pay 6.14%. That’s a spread of 2.11 percentage points in favor of the bond.
If the Fed continues to push short-term rates lower, which seems all but certain, returns on T-bills and short-term bank CDs are going to become increasingly anemic. You’re going to feel compelled to invest your money elsewhere, and that’s going to mean buying bonds and other higher-paying, longer-term instruments.
You shouldn’t just rush out and dump all your cash into a 30-year T-bond, of course. But if you still haven’t moved any funds into longer-term investments, the bell is ringing. Even 7-year T-notes still are paying nearly 8%. If short-term T-bills drop to 5% in a few months, 8% will feel very good.
Hanging Up on Phone Stocks: Investors in the former Baby Bell phone companies got a rude wake-up call on Tuesday. Poor earnings reports from Pacific Telesis and Bell Atlantic shocked the market, sparking a selloff of all seven of the major regional phone companies.
PacTel plunged $3.125 to $41.25, a 7% drop. Bell Atlantic gave up 7.4%, losing $4 to $50. Southwest Bell tumbled 4.8%, off $2.625 to $52.625. The other four also fell, though less so.
PacTel’s bomb was a 40% drop in fourth-quarter earnings. But beyond the latest quarter’s troubles--partly a result of consumer and business phone-usage cutbacks as the economy slumps--PacTel deeply disturbed investors with a forecast of “material dilution” in earnings over the next two years. The dilution will stem from heavy capital spending on European ventures, such as a cellular phone network for Germany, the company said.
And therein lies the problem with the big phone stocks today, says Geoff Johnson, analyst at Argus Research in New York: “Are they cellular companies, are they utilities, or are they a multinational play?” he asks rhetorically.
The companies are in a transitional phase as they get set for an increasingly global communications market in the 1990s. But this phase may not sit well with investors who traditionally have owned phone stocks for consistent earnings and dividend growth.
Philip Dubuque, who manages the Financial Programs Utilities stock mutual fund in Denver, sold all of his phone stocks in November. He has a laundry list of concerns about these stocks in 1991:
* They’ve never been through a recession as separate companies (remember, Ma Bell was only broken up in 1984).
* Dividend growth will almost certainly have to slow as earnings slow, especially since the average Baby Bell now is paying out 72% of earnings as dividends, up from 40% to 50% in the 1980s.
* Growth in cellular phone operations, one of the phone companies’ hottest businesses, has been below expectations by some accounts.
But won’t the stocks become bargains at some point, just based on their dividend yields? That also may be a problem, because even at their newly clipped prices, the stocks’ yields aren’t all that great: PacTel’s annual dividend yield now is 4.9%; Bell Atlantic’s is 4.7%. Most of the seven yield about 5%.
To Dubuque, a 5% yield isn’t enough to get investors interested again--especially when many electric utilities pay 7% or higher yields. He believes that the phone stocks could fall another 10% before yield-oriented investors even begin to look at them. If PacTel falls another 10%, to around $37, the dividend yield would be about 5.5%, based on the $2.02-a-share annual dividend.
Rich Lazarchic, who manages the IDS Utilities stock fund in Minneapolis, didn’t sell his PacTel shares on Tuesday. He thinks the stock is “pretty close to a decent value” at the current price. But he admits that after Tuesday’s earnings shockers, “these stocks aren’t going to turn around tomorrow, that’s for sure.”
Time To Go Long? As short-term interest rates have continued to fall, the difference between three-month Treasury bill rates and 30-year T-bon yields has widened dramatically.
