One on One With Jack Malvey, Chief Global Fixed Income Strategist at Lehman Brothers
Wednesday, August 09, 2006
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SUSIE GHARIB: Traders in the bond market today were still analyzing the decision by the Federal Reserve to hold interest rates steady and the outlook for inflation. Our guest tonight believes more rate hikes are on the way. Joining us now, Jack Malvey, chief global fixed income strategist at Lehman Brothers. Hi Jack.
JACK MALVEY, CHIEF GLOBAL FIXED INCOME STRATEGIST, LEHMAN BROTHERS: Hi.
GHARIB: Tell us why you think that more interest rate hikes are on the way.
MALVEY: Well, if we just heard earlier in your program, there`s a risk that energy prices could again ascend and there seems to be still some inflation in the system. We think the Federal Reserve will be induced to probably tightened at least two more times before they conclude this tightening cycle.
GHARIB: There are some people in the market who are already talking about rate cuts by the Federal Reserve. They say the rule of thumb is after the last rate cut, six to nine months, you begin -- after the last rate hike, you begin six to nine months later with rate cut. Obviously you`re not in that camp. MALVEY: That`s approximately true. The question is when is the last rate hike and we would put the last rate hike probably closer to the end of this year as opposed to June of 2006. So there`s some way to go. By the end of 2007, there indeed could be a first rate ease from the Federal Reserve.
GHARIB: It`s very rare to see the yield on the 10-year Treasury below the Federal funds rate which is now at 5.25 percent. What does this suggest to you?
MALVEY: There`s a lot of risk aversion in the markets still. This time of year, capital market risk season peek, August through October, equities and all sorts of variables tend to be a little bit more volatile historically and certainly market practitioners are well aware. In addition, it is the case that we have continued strong demand for non-U.S. investors for U.S. fixed income securities.
GHARIB: Does it give any indication about how the bond market is assessing the credibility of Ben Bernanke, the Federal Reserve chairman?
MALVEY: I think the bond market now well understands the new chairman and certainly does assign a high degree of credibility to the Fed policy. Over the course of the last week, it was clear that the Fed would probably pause and their statement and their action this week conform with the vast majority of expectations.
GHARIB: When you see a gap between the 10-year yield and the Federal funds rate, what do you see as the chief of concern in the bond markets? Is it that inflation is a problem or is it the worry that the economy may be slowing so much that there`s a risk of recession?
MALVEY: Well, you raise an excellent question. It does point to a deeper contradiction and there`s a bit of a schism in the capital market. There are those who would assign a higher probability to growth deceleration as a major risk and there are others, maybe more classic fixed income investors, who maybe worry more about inflation risk over the course of the next six to nine months. As a result this contradiction results in this current configuration between short rates, the Federal Reserve funds rate being higher than the 10-year rate at this time.
GHARIB: Where are you in that debate? What`s your view?
MALVEY: I`m an old school classicist. I`m more worried about inflation. We very much hope the Federal Reserve has it right and that we will begin to see demonstrably for sure deceleration inflation by the end of this year and into 2007. GHARIB: So if you own bonds as a bond investor, what should you be doing with your bond portfolio right now given all of this uncertainty?
MALVEY: Bonds are more attractive certainly over the course of this year compared to two, three years ago, thanks to the escalation of rates at the short end by the Fed. In general, we will be rolling over portfolios in the short and intermediate sectors. We think that rates might be a little bit higher yet over the next three to four months as the Fed finally concludes this tightening cycle. But looking into 2007, we do think that investors should consider an increased allocation to fixed income. This asset class is now more attractive arguably than any time since 2002.
GHARIB: Today`s auction of 10-year Treasuries was characterized by many people as lackluster. Can you give us a quick answer of why things didn`t go so great?
MALVEY: Well, I think that it really was maybe not a terrible surprise. It`s at this time of year and we`ve had a lot of good news in the bond market over the course of last month. July was the best month in almost two years for the U.S. bond market and we got the expected Fed pause. The bond market is evidenced by the little sell-off today is taking a bit of time out. Not surprising it would affect the auction to a minor degree as well.
GHARIB: Jack, thank you so much for coming on the program. We really, really appreciate it.
MALVEY: Thank you.
GHARIB: We`ve been speaking with Jack Malvey, chief global fixed income strategist at Lehman Brothers.
