Reduce liability for losses on commercial accounts by adhering to four requirements.
Got Yield? (Probably Not.)
We are now officially past the halfway point for 2010 and probably the most surprising thing so far is how short-term interest rates have remained at historically low levels. I guess the Fed really meant it when they placed the words “an extended period” in the minutes after each Federal Open Market Committee meeting this year.
Keep in mind that we have a Great Depression expert running the Fed. I read his book on the subject and he cites a lack of confidence in the financial system at the time as perhaps the principal cause, although there were obviously many contributing factors, including the Smoot-Hawley Tariff Act and speculative stock trading by banks.
Another one of those factors was the Federal Reserve’s interest rate policy at the time and the consensus now is that they probably raised rates too quickly as the economy recovered from the worst recession in U.S. history. In fact, some experts feel the rate increases might have actually extended the Great Depression. Chairman Bernanke as a great student of history will simply not repeat that mistake, in my opinion.
This extended low-rate environment certainly makes it difficult to invest money wisely as almost all of the alternatives now seem to be trading off some form of risk in order to produce reasonable yields. We are all flush with cash (there are reports of $10 trillion in cash parked on the sidelines) due to slack loan demand and unusually high deposit inflows. Can you remember a time when lowering your deposit rates actually made your bank deposits grow?
It is tempting now to reach for yield and consider longer bond maturities, lower quality issues and weaker payback structures to maintain a reasonable net interest margin. In the past, these conditions have always been warning signs for bank bond portfolio managers as we always have too much cash to invest at the wrong time, and vice versa. We call this the bond trap, and it is often not our fault.
Although the economic data continues to generally show improving V-shaped conditions, the near meltdown in Greece and other domino-like deflationary concerns in the European Union have served to make dollar-denominated assets like U.S. Treasuries popular safety bets. When will this global safety bet pass? Soon, I hope.
My two previous columns were entitled Patience! and Is the Bond Bubble Losing Air? and I think these themes still make sense in retrospect. In my opinion, the longer the Fed and negative economic events keep the short-term bond price bubble from bursting, the greater the chances of a sharp rate reversal. Think of it as adding more and more kindling on top of an already smoldering campfire.
Kansas City Fed President Tom Hoenig has expressed his inflation concerns very bravely by dissenting at the last three FOMC meetings. His point is that we have lowered rates much lower than the 1 percent level necessary just after the 9/11 attacks and that starting the reversal process now might reduce the chances of a rate spike later. I think this makes good sense, and the 1970s interest rate history supports his theory. The trillion dollar question now is whether this time period is the most appropriate one in history for us to study.
You can see in the chart how banks in the UMB Peer Group are performing now in terms of bonds with the top group yielding 8.70 percent if you add in their bond gains. You may wish to jot down your results in the spaces provided in the chart for comparison with these numbers. If you have any questions about the categories or the results, email me.
Jeff Goble is executive vice president and managing director, investment banking, at UMB Bank, n.a., Kansas City. His email address is Jeffrey.Goble(at)umb.com.
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