Rates Could Stay Low

by Alan Lavine and Gail Liberman

Some investment pros look for higher interest rates this year due to an economic rebound.

But Jim Swanson, fixed income strategist at MFS, Boston, sees the market differently. He does not expect rates to rise later this year. He cites Alan Greenspan's recent comments that the economy is stabilizing, but there still are risks. The recession could last longer than expected. The big problems are weak profits and business investment and restrained household spending caused by rising unemployment.

"We take a different view," Swanson says. "The recession came about because business spending declined. Industry had too much capacity and over investments. The demand for capacity utilization is 75 percent and still coming down. There is no near-term demand to push rates up."

Swanson says that over the last five recessions, rates fell during the initial stages of the recovery. Rates did not go up for 8 to 12 months after the recessions peaked. He also sees no inflation risk.

Swanson says high-grade corporate bonds now represent the best values. He sees the difference in yields between corporate bonds and Treasuries narrowing. So if you buy now you can get higher rates, plus corporate bond prices could rise.

As the recovery continues, he says high-yield or junk bond prices will rise. The reason: High-yield bonds do best when the stock market shines. This year ending in January, junk bonds already are up over 7 percent.

Swanson sees the bond market delivering solid returns this year. Over the next year, he estimates corporate bonds will return 7 to 9.5 percent. Meanwhile, junk bonds could register double-digit total returns.

"When people begin to take on risk and buy stocks, they also buy other types of securities with upside potential and more risk."

Nevertheless Swanson is not an outright bull. Bond defaults could hit 10 percent this year. As a result, MFS's bond funds stick with bonds that mature in the two-year to eight-year range.

Swanson recommends that investors keep a core holding of short-term Treasuries and agency paper. Ten percent, he suggests, should be invested in high-yield bonds and the rest in investment grade bonds rated single A to triple A by Standard & Poor's and Moody's.

Alan Lavine and Gail Liberman are husband-wife personal finance columnists, journalists and authors. They are the authors of "The Complete Idiot's Guide to Making Money with Mutual Funds," published by Alpha Books. Their columns appear in newspapers throughout New England and the Southeast, as well as online. Their commentary on mutual funds and personal finance is carried by 200 radio stations nationwide every Sunday over Business News Network's Charles DeRose Financial Advisor Show.

More articles by Al and Gail can be found here.