A lesson from the Sixties

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The Independent Online
THE inflation rate is below 2 per cent, interest rates are near rock bottom. Actually, the year was 1961. Kennedy, not Clinton, was at the nation's helm. Then as now, a combination of steady economic growth and scant inflation helped keep US bond yields low. Except then, benchmark yields were trading at 4 per cent and under - more than a full point below current levels.

The inference that should be drawn, say some investors, is that US yields should be lower now. "That's been my thesis for a long time," said William Gross, bond manager at Pacific Investment Management in California.

Bullish bond investors such as Gross are making their prediction for lower yields even after US bonds surged on Friday, rounding out another good week for Treasuries and driving benchmark 30-year yields to the lowest in more than 20 years.

Bonds climbed after investors snapped up Treasuries as a refuge from financial turmoil in Russia, Asia and Latin America, and from tumbling global stocks. Friday's gains pushed 30-year yields as low as 5.38 per cent.

Some investors say yields are poised to go lower still because what kept yields low in the 1950s and 1960s is present today: an environment of sustained, subdued inflation.

"Someone who believes that 5.40 per cent is low is ignoring the experience of the Fifites and Sixties", when inflation was almost nonexistent and yields were low, said Brian Wesbury, chief economist at Griffin, Kubik, Stephens & Thompson in Chicago.

Mr Wesbury is among investors who expect turmoil overseas to curb US growth, keep prices from picking up and even possibly prompt an interest rate cut by the Fed. In this scenario, 30-year yields could fall to as low as 4.50 per cent, he said. Others agree.

Some investors, though, say the recent rally is more a reflection of investor's flight to Treasuries as a safe haven. "At this stage, we are trading non-domestic fundamentals," said John Burgess, at Bankers Trust Global Investment Management. "It's about flight to quality."

Bulls argue that with the crises overseas, the economy will lose more steam. That is hurting stocks, which were hit by worry that US companies will struggle to boost profits in the face of recession in Asia. Banks led decliners on expectations that they will suffer big losses in emerging market debt and loans.