Last year investors were concerned that the Fed wasnât aggressive enough in slowing the economy. They feared that Alan Greenspanâs 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.
Djˆ 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.