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Bond Yields Take a Steep Tumble

The Fed's worries about the economy may keep interest rates depressed into 2004, some say.

May 08, 2003|Josh Friedman and Tom Petruno | Times Staff Writers

Yields on Treasury bonds slumped again Wednesday, falling closer to the generational lows reached in March, as more investors bet that the Federal Reserve may not be done easing credit to help the economy.

The fresh slide in yields may be good news for home buyers, and possibly for the stock market. But lower rates will add insult to the injury that many savers have been feeling for the last two years, as their money has earned the poorest returns in more than four decades.

The yield on the 10-year Treasury note, a benchmark for mortgage rates, dropped from 3.78% on Tuesday to 3.68% on Wednesday. That is the lowest since the week of March 10, when the yield bottomed at 3.56% -- a rate last seen in the 1950s.

Yields on shorter-term Treasury securities also either declined Wednesday or held steady after falling Tuesday.

The catalyst for the latest drop in yields was the surprise announcement by Fed policymakers Tuesday that they are concerned the economy could fall into deflation -- a broad and sustained decline in prices. That has been the story in ailing Japan for several years, and it brings back memories of the Depression years in the United States.

The Fed signaled that it is leaving the door open for additional interest rate cuts to help boost the economy, even though its key short-term rate already is at a 40-year low of 1.25%.

At a minimum, analysts said, the Fed won't be tightening credit anytime soon, even if business and consumer spending shows more signs of picking up.

Though the Fed characterized the deflation danger as minor, it will be hesitant to hurt the economy by raising rates "preemptively," said Richard DeKaser, chief economist at banking firm National City Corp. in Cleveland.

"Until now, I had been betting on a fourth-quarter rate hike, but this diminishes that possibility and makes 2004 a safer bet," DeKaser said.

For savers earning paltry yields on money market mutual funds and other short-term accounts, the Fed's message was clear: It may be a long time before you earn higher returns.

Even as the central bank keeps its key rate unchanged for now, money market fund yields could go lower if investors continue to bid aggressively for fixed-income securities, figuring that there's a chance the Fed could push rates lower.

Indeed, the average seven-day annualized yield on money funds dipped to a record low 0.70% this week from 0.71% last week, according to rate tracker IMoneyNet Inc.

The yield on six-month T-bills was at 1.11% on Wednesday, down from 1.20% three weeks ago. The yield on two-year T-notes ended Wednesday at 1.41%, down from 1.7% three weeks ago.

At the Treasury's sale of new five-year notes Wednesday, demand was robust, and the notes sold for a yield of 2.68%.

Falling Treasury yields can drive down other savings yields, such as on bank accounts.

For savers, "this is very unwelcome news," said Greg McBride, senior analyst at Bankrate.com in North Palm Beach, Fla. The Fed is "going to leave short-term rates low enough relative to inflation to incite spending rather than saving."

More than $5 trillion is sitting in short-term accounts including money funds and bank savings accounts. That sum has mushroomed over the last five years as many Americans have sought safety rather than take a chance on riskier investments.

Optimism about an economic rebound in the second half of this year had stoked expectations that short-term interest rates might begin to rise. Now, those expectations have been dashed.

The likelihood of the central bank keeping rates depressed for an extended period is reminiscent of 1992-93: After slashing rates in 1991 and early 1992, the Fed held its key short-term rate steady for 17 months before beginning to tighten credit in February 1994.

For borrowers, the Fed's stance could be a boon, of course. Many economists believed that mortgage rates bottomed in March. But if Treasury yields continue to fall, mortgage rates could as well.

Even so, "I would not gamble and postpone [getting a mortgage] because rates might go down" further, said David Lereah, chief economist at the National Assn. of Realtors in Washington. "You've got an opportunity to lock in the lowest rates in 40 years."

With 30-year mortgage rates at about 5.7%, near the all-time low of 5.6% reached in March, they are not likely to fall more than 0.1 point unless the Fed does ease again, Lereah said.

Still, if employment and manufacturing statistics remain weak, the Fed could cut short-term rates a half-point without waiting for its next official meeting in June, said Doug Duncan, chief economist at the Washington-based Mortgage Bankers Assn. of America.

The Fed's position on rates might encourage more investors to consider accepting the risk -- and possible reward -- of pushing money into stocks, some analysts said.

"Longer-term investors have recently shown a willingness to begin allocating a little to stocks, and the market has seen a nice bounce because of that," McBride said.

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