Is Fed rate cut on the horizon?
Wall Street this week appeared to surrender any hope it had for a Federal Reserve interest-rate cut this year, but some analysts still insist that lower rates are just a matter of when, not if.
That sentiment may have helped the Treasury bond market recover Friday from a heavy sell-off in the previous three sessions. Stocks also rebounded sharply.
The yield on the 10-year Treasury note, a benchmark for other long-term interest rates, soared as high as 5.25% early in the session, a one-year peak and up from 5.13% on Thursday.
But then buyers poured in and rates fell. The 10-year T-note ended the day at 5.11%.
That helped give stock investors the confidence to jump back in: The Dow Jones industrial average rallied 157.66 points, or 1.2%, to 13,424.39.
Bond yields surged worldwide this week as investors focused on strength in the global economy and the likelihood that many central banks either would continue to raise short-term interest rates or, at best, hold them steady.
On Tuesday, Federal Reserve Chairman Ben S. Bernanke said he expected the U.S. economy to grow at a “moderate pace” in the near term. His comments further damped hopes that the Fed might lower its key short-term rate, now 5.25%, in the second half of the year.
But many analysts believe that the slumping housing market and high gasoline prices will be major drags on consumers’ mood and their spending this year, and that the economy will need lower rates to avoid falling into recession in 2008.
Bill Gross, the bond market guru at Pacific Investment Management Co., or Pimco, in Newport Beach, was credited Thursday with helping to fuel the sell-off in bonds, after he said in an interview posted on Pimco’s website that the 10-year T-note yield could rise as high as 6.5% in the next five years.
Yet Gross also said he still expected the Fed to cut short-term rates later this year because “we continue to see a weak U.S. economy, based upon housing.”
David Rosenberg, chief North American economist at brokerage giant Merrill Lynch & Co., this week abandoned his prediction for Fed cuts in 2007. But he told clients in a report Friday that lower rates had been delayed rather than derailed.
“We continue to believe that the next move by the Fed will be an ease, but we are now thinking early 2008 as opposed to late in the summer or early fall,” he said.
Mortgage rates have risen with bond yields since March, which will make things worse for home sales, analysts say. What’s more, homeowners with adjustable-rate mortgages that reset in the second half already were facing a steep increase in payments; rising interest rates could make it harder to refinance.
“The Fed has yet to see the fallout from the housing market,” said Michael Cheah, a bond fund manager at AIG SunAmerica Asset Management in Jersey City, N.J. He also believes there’s a strong chance of a Fed rate cut in 2008, he said.
One sign that many bond investors believe the Fed will ease credit in the next year or so is that yields on even the longest-term Treasury bonds remain below the Fed’s short-term rate. If investors expected the Fed’s rate to stay level or rise, it wouldn’t make sense to accept lower yields on longer-term bonds.
But other factors have been depressing bond yields in recent years, including heavy buying of Treasuries by foreign investors such as China’s central bank.
Now, competition from rising interest rates in Europe and Japan -- as those economies expand -- could put upward pressure on U.S. bond yields even if the domestic economy is weak, some experts warn.
Rosenberg cited foreign rate pressures as one reason the 10-year T-note yield might rise as high as 5.5% in the third quarter before falling again by year end.
Technical trading strategies by institutional bond investors who’ve been shaken up by the jump in yields this spring also could boost volatility in the market near term, analysts warn.
As for the stock market, bullish investors believe the outlook for the U.S. and global economies favors rising corporate earnings, supporting stocks.
“Nothing fundamental has changed” for equities, said Al Kugel, chief investment strategist at Atlantic Trust in Chicago.
Other analysts, however, warn that rising interest rates could raise the cost of bond financing for corporate takeovers. The boom in takeovers has helped underpin stock prices this year.
The average yield on corporate junk bonds stood at 7.39% on Friday, up from 7.14% a week earlier and the highest since November, according to KDP Investment Advisors.
Among Friday’s market highlights:
* The Dow’s gain of 157 points recouped 38% of the 410 points it lost from Tuesday through Thursday. The Dow, which closed at an all-time high of 13,676.32 on Monday, was down 1.8% for the week.
The Nasdaq composite Friday jumped 32.16 points, or 1.3%, to 2,573.54, and the Standard & Poor’s 500 rose 16.95 points, or 1.1%, to 1,507.67. For the week the Nasdaq lost 1.5%; the S&P; index dropped 1.9%.
* A slide in oil prices helped the stock market. Near-term crude futures in New York fell $2.17 to $64.76 a barrel amid a broad retreat in commodities.
