We do not expect any Fed tightening until the middle of 2005. We think Fed officials will be patient, because it will take a long time for the economy to use up its excess slack. And, that is necessary to push inflation higher. The Fed is in a reactive rather than preemptive mode because inflation is below the level that is desired.
Why have the Bank of Japan and other Asian central banks recently been buying 10-year Treasuries instead of short-term assets?
The purchases are mainly tied to foreign exchange intervention that is designed to slow their currencies' appreciation against the dollar. They are buying dollars and investing the proceeds into U.S. Treasuries.
How do the weak dollar and the U.S. government's goal to keep it weak affect the attractiveness of U.S. assets?
If the dollar declines in a gradual and orderly way, then this should not pose problems for the U.S. fixed-income market. However, if the decline became disorderly, then it probably would lead to higher bond yields, at least temporarily. So far, the decline has not caused any significant disruptions to the U.S. Treasury market.
Can low savings rates be sustained and if not, what does that mean for the bond market?
Households do need to save more. To do this implies that consumption has to grow slower than income. This is a reason why consumer spending growth, which has been very robust, can be expected to slow a bit, especially in the second half of the year when the positive impulse from fiscal policy will be exhausted.
Do economic fundamentals justify how tight corporate spreads are? Which factors in particular signal that spreads should be where they are?
Yes, narrower spreads are justified by three developments. The sharp improvement in corporate cash flow and profitability, the sharp swing in the corporate financing gap from positive to negative (the financing gap is the difference between corporate investment and cash flow) and the drop in the net supply of corporates relative to the increasing supply of U.S. Treasuries.
With such low yields, how much of a concern should inflation be for fixed-income investors?
Inflation is a reasonable item to focus on, especially given the Federal Open Market Committee's desire to push inflation higher. That said, inflation is about pressure on resources. So, inflation is not likely to rise until excess resources are exhausted. That is likely to be a 2005 or 2006 story, not a 2004 story.
The TIPS market has grown by leaps and bounds in recent years--do you think investors should continue to tie their investments to the CPI and will these bonds become more attractive in an improving economy?
TIPS have done very well. The reason is that they really are lower-risk investments than nominal Treasuries, as you are protected against inflation. TIPS would likely outperform nominal Treasuries by a significant margin in a rising-inflation environment.
Is President Bush's prediction that 2.6 million jobs will be created possible?
It will be difficult but certainly possible. The labor market has not come even close to generating jobs at that rate, but the labor market is improving. To reach that, however, it has to improve soon. How those jobs will be created is a combination of much-reduced job losses in the manufacturing sector and large job gains in the services sector.
How and why will election-year politics affect the economy and the bond market?
The effects are likely to be very modest as long as market participants continue to anticipate a George Bush victory. Even if the Democratic candidate looks more probable of winning, the Republicans are still likely to retain control of Congress. So, the impact on the markets is likely to be small.
The election, however, could conceivably affect the timing of monetary policy tightening. Historically, Fed officials have not liked to tighten right before an election. So if they do not start by June, they probably won't begin until after the election. However, given our view that they won't begin until the middle of 2005, the election is not likely to be an issue for the Fed.
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