Tags: bernanke | fed | bond | yields

Bernanke Seizes Day to Lower Bond Yields as Congress Shirks

Friday, 12 Aug 2011 03:23 PM

 

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Federal Reserve Chairman Ben S. Bernanke’s flattening of bond yields may be just the push investors and companies need to take risks with their cash.

The Fed’s decision this week to keep its benchmark interest rate near zero through mid-2013 sent five-year Treasury yields as low as 0.82 percent, below the 2.21 percent two-year rate before the collapse of Lehman Brothers Holdings Inc. in 2008. Lower returns on the safest investments will spur equities purchases, said David Kelly of JPMorgan Funds.

“The Fed’s making it extremely painful not to take on some risk,” said Kelly, who helps oversee $408 billion as chief market strategist for the New York-based firm. “People will tend to push money into equities.”

Bernanke and his colleagues acted days after a deal to raise the debt ceiling and reduce federal budget deficits failed to avert a cut to the nation’s AAA credit rating by Standard & Poor’s. The central bank’s decision, and a signal it’s willing to take further action, helped spur a rally in U.S. stocks from an 11-month low.

“This is aimed at encouraging people to leverage up, with the knowledge that their borrowing costs will likely be very low for a long period of time,” said Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey.

The Standard & Poor’s 500 Index rose 0.5 percent to 1,178.29 at 10:25 a.m. in New York today, extending yesterday’s 4.6 percent gain.

Declining returns on savings accounts and certificates of deposit may encourage consumers and corporations that have been hoarding cash to start investing it, JPMorgan’s Kelly said.

Buying Back Stock

“The lower yields are, the more these companies are going to have an incentive to either invest directly in the stock market or even simpler, just buy back their own stock,” he said. “The incentive for a clear-thinking CEO must be huge.”

Companies stockpiled a record $1.9 trillion in cash in the first three months of 2011, according to the Fed data from June. Bank of New York Mellon, the world’s largest custodial bank, said Aug. 4 it will begin to charge institutional clients for “extraordinarily high” cash deposits to stem a flight of capital into the safety of bank deposits.

Americans saved 5.4 percent of their disposable income in June, the Commerce Department said this month. That’s up from a 5 percent rate in May and is the highest since September 2010. It was 1.5 percent in 2005, the lowest since at least 1959, amid the housing boom and 3.1 percent economic growth.

Certificates of Deposit

Savers are getting average interest rates on 6-month certificates of deposit this week of 0.58 percent nationwide, down from 0.60 percent last week, according to Bankrate.com. Rates on one-year CDs fell this week to 0.86 percent, while 5- year CDs fetched 2.04 percent.

The Fed said it would keep its target for overnight loans among banks at a record low for at least two years to support a recovery that’s “considerably slower” than anticipated.

Two-year Treasury yields have become the equivalent of short-term bills, with rates declining to 0.18 percent yesterday, about the same as the average yield on three-month bills over the past three years.

“The Fed has vindicated its power over the term structure of interest rates by being clear about the expected path of short-term rates,” said Peter Fisher, head of fixed income at BlackRock Inc., the world’s biggest asset management firm, who was markets chief at the Federal Reserve Bank of New York from 1994 to 2001. “It does encourage those looking for returns to look in credit assets and then further out the yield curve.”

Yields on investment-grade corporate debt average 2.01 percentage points higher than comparable Treasuries, according to data from Bank of America Merrill Lynch.

Operation Twist

The Fed’s action is reminiscent of a joint action with the Treasury Department known as Operation Twist intended to pull the nation out of a recession in 1960-1961. The Fed purchased longer-dated Treasury bonds and sold short-term bills in a bid to flatten the yield curve.

One difference, according to Fisher: Bernanke is trying to create very low short-term rates, while Operation Twist was focused on reducing longer-term borrowing costs.

The Fed’s action this week may also have another purpose, said Marvin Goodfriend, an economics professor at Carnegie Mellon University in Pittsburgh.

“It is mainly a signal that the Fed will do more, including buying government bonds, if the Fed believes the economy needs it,” said Goodfriend, a former research director at the Richmond Fed. The Fed in June ended a $600 billion bond- purchase program.

© Copyright 2014 Bloomberg News. All rights reserved.

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