Rates Will Fall Further

12/19/2007 12:00 am EST

Focus: MARKETS

Mary Anne & Pamela Aden

Co-Editors, The Aden Forecast

Pamela and Mary Anne Eden, editors of the Aden Forecast, say that the Fed will continue to cut rates to stave off recession, and investors will continue to buy bonds.

Interest rates are headed lower.

Even though they declined at the [Federal Open Market Committee's] meeting on December 11, most of the markets agreed that it wasn't enough.

The markets wanted to see an interest-rate decline of half a percentage point. That's what we were expecting, too, as it would have been an aggressive drop and a strong sign that the Fed's very concerned about the economy.

But the Fed quickly did an about-face, announcing its new liquidity plan in coordination with other central banks. This suggests that the Fed believes the subprime problems will be alleviated by the new Bush and liquidity plans to help subprime borrowers, and the housing sector won't drag the rest of the economy down.

Interest rates have already been lowered four times in recent months, but this month rates literally plunged across the board. The short-term treasury-bill interest rate, for example, fell from 3.36% to 2.87%, and that's down from 5.05% earlier this year. So, there's no question that the major trend is down and as long as that's the case, interest rates are going lower.

The same is true of long-term interest rates. The 30-year yield has dropped from 5.36% to 4.28% this year, reinforcing that the overall trend is down. The ten-year yield [also] has dropped sharply to an over two-year low. (It fell as low as 3.89% earlier this month and closed Tuesday at 4.12%- Editor.) That's because investors turned to the safety of government debt as losses mounted in the stock and credit markets, which quickly drove interest rates down.

But this dash to safety pushed the yields so low that interest rates are poised to rise further from these oversold levels.

That doesn't mean a change in the major interest rate trend. It'll remain down even if the ten- and 30-year yields rise to 4.65% and 4.84%, respectively. And with the major trend down, the Fed will continue to lower interest rates in the months ahead. Basically, the Fed knows that the economy is still vulnerable and the Fed will likely keep lowering rates until it's sure that the economy is safely out of the woods.

If you have bonds, we'd continue to hold them. If you want to buy new bond positions, we'd still wait to buy on weakness as prices come down. If you do buy bonds, or are holding them, we'd be very cautious. Even though they've been doing well lately, keep in mind that other investments have been, and continue to be, much better. Plus, once inflation starts picking up in reaction to all the pumping that's being done to keep the economy afloat and rising commmodity prices, it's going to be terrible for bonds.

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