Will Interest Rates Increase or Decrease in 2010/2011?

Note the article below by Morgan Stanley Smith Barney. It notes the possible scenario for interest rates in 2010 and into 2011. If you’re wondering “Will interest rates rise?” In a nutshell, this sort of gives the case for rates to not go much higher until 2011 or later.  30 year mortgage rates tend to stay about 1-1.5% higher than the 10 year treasury. Today the 10 year is at 3.4% and 30 year mortgage rates are about 4.8.  So, at best we could see 5.5 to 6% mortgage rates by year end. It’s not an exact science, just a rough estimate of what interest rates may do this year and into 2011. There are still great housing deals in Northeast, Ohio. Interest rates right now are low and so are home prices. It’s a great time to invest, refinance, move up or buy your first home.

Tactical Strategies for Moderately Rising Rates in 2010
Now that the economy is showing signs of life both domestically and globally there is talk of central banks reigning in liquidity measures in 2010. Here in the US, a combination of a less accommodative policy by the Federal Open Market Committee, robust Treasury supply to help fund the fiscal deficit, and increased market expectations of rising inflation should all lead to higher Treasury rates in 2010.

In the Morgan Stanley Smith Barney base case scenario, we envision rates rising all along the maturity spectrum, but as the year progresses, investors could very well see some key distinctions between shorter-term and longer-dated instruments. Based upon recent public commentary from Fed officials, as well as the accompanying policy statement following the November FOMC meeting, it would appear that policymakers are in no hurry to raise rates any time soon. As a result, it seems reasonable to expect the Treasury yield curve to maintain its steep construct longer thaninitially envisioned, with the possibility that some further incremental widening could occur. However, once the market foresees the first tightening move on the horizon, we feel the next significant move will be a ‘bear flattening’ in the yield curve, a situation whereby all rates will rise, but by a greater magnitude in the front end.

The Morgan Stanley Smith Barney Global Investment Committee (GIC) has a broad asset class view that is
underweight global bonds and cash and overweight global equities and alternative investments. Within global bonds the GIC is overweight on corporate, high yield and securitized bonds but underweight on government/government-related short duration bonds. This report provides tactical asset class recommendations in-line with the GIC view based on our scenario for rates in 2010.
Base Case Scenario
Expect the US Treasury (UST) 10-yr note to trade in a fairly tight range between 3.25% and 3.75% through the end
of 2009, then move upwards in 2010, ending the year around 4.25% to 4.625%.
Key strategies: Taxable Fixed income
Key strategies: Municipals
Target 5-yr to 7-yr maturity sector
Target 5-yr to 13-yr maturity sector
– For conservative investors, CDs potentially offer the best
– Upgrade credit quality where possible. value inside of 5 years.
– Consider essential service revenue bonds, state
– Consider Buy: Corporate Investment Grade: Sectors general obligation bonds and state appropriated benefiting from economic recovery and that historically paper. hold value during rising rates: Forest & Paper, Metals/
– For those in lower tax states (6% max state rate Mining, Cable and Consumer Goods. or below) consider diversifying geographically.
– Consider Buy: Emerging Markets: Exposure to countries
– Add “A” rated & a modest amount of upper likely to benefit from a rebound in global economic “BBB” rated general obligation bonds from large activity, such as Brazil and Chile. Issuers to add yield in a diversified portfolio.
– Consider Buy: Non-USD: Favor currencies of countries Avoid smaller/weaker issues. Pulling out of recession early. Keep maturities short.
– Focus on premium priced bonds generally.
– Consider Sell: Preferred Securities. Higher long- term
– Consider pre-refunded bonds to add quality and rates serve as a negative force. stability.
– Consider Sell: Govt/Agency MBS. Asset class already revealing signs of being too ‘rich.’ Higher long-term rates increases potential for extension risk.

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