Analysts say rates will continue to increase; how much is unclear

That was the message from Bank of America investment rate strategist Robert Podorefsky at a luncheon seminar Jan. 19 at Springfield’s University Plaza and Convention Center.

The seminar, “Interest Rates at Center Stage – A 2005 Risk Outlook,” focused on past trends in interest rates and how those trends have affected other financial sectors. It also offered predictions on what interest rates will do in the future.

In his presentation, Podorefsky said he expects the Federal Reserve Board to continue to raise the prime interest rate for the foreseeable future. He also talked about what is happening to LIBOR – the London interbank offered rate, which is the rate that banks in the London interbank market borrow money from each other. It’s usually considered the benchmark for short-term interest rates internationally.

“If you look at what happened to LIBOR in the last three months of 2004, rates increased almost nine-tenths of a basis point per day on average,” he said. “That puts you in a position by the end of 2005 where short-term interest rates will be at about 4.5 percent.”

He added that the prime rate, which currently sits at 2.25 percent, should be up above 4 percent by the end of 2005, putting it in line with LIBOR estimates.

Fed Chairman Alan Greenspan has been direct in his approach. On Nov. 19, he said, “Rising interest rates have been advertised for so long and in so many places that anyone who has not appropriately hedged this position by now obviously is desirous of losing money.”

Ronald Smouse, investment adviser with Mid-Missouri Investment Centers, said he agrees with that assessment, to a point.

“I’m anticipating this year the Fed raising (the prime rate) another 1 percent and then stopping, because they want to raise the rate, but they don’t want to raise it too fast,” Smouse said. “People equate the interest rate and borrowing money to stocks, and they think if they raise the rates too fast it’ll hurt the market, but at the same time the Fed started the upswing in the rates on purpose to try to spur the economy and get the rates back up where people can live.”

The international market is a significant factor in the Fed’s delay to raise rates. Podorefsky said that foreign investment has buoyed the economy, especially in U.S. Treasury bonds.

Smouse said foreign investment is important, which is why the rates should increase.

“The other reason they want to drive up the rates, which makes sense, is that a lot of our T-bills are bought by foreign investors,” Smouse said.

“With the low rate that they had, they had quit buying, so by getting the rates up, they’re hoping to get the foreign investors back buying securities.”

Smouse added that the real problem is the weak dollar.

“The dollar plunged against the euro, and it’s been at an all-time low lately, which is helping the import business,” he said. “Our trade deficit is getting bigger every day, which I think is a major problem, but nobody seems to care right at the moment.”

The biggest question mark for the economy is inflation. Podorefsky said inflation is impossible to predict because it’s not simply reliant on numbers.

“The inflation story intrigues me more than anything, because inflation is not only an outcome but a state of mind,” Podorefsky said.

“The risk here is that as it creeps even higher, people’s expectations of future inflation will shift. If that does happen, it can have its own self-fulfilling impact on prices.”

Smouse said he’s not overly worried about inflation.

“So far, (raising the rates) hasn’t affected much of anything,” he said. “There’s no sign of inflation out there, and I don’t think another 1 percent’s really going to hurt the economy or the interest rate environment at all.”

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