Predicting Interest Rates: Who Got It Right?

By Cyril Tuohy

InsuranceNewsNet

You’ve got to hand it to those interest rates. They’ve done a number on the “smart money,” which by this time last year pegged rates to start rising as the Federal Reserve cut back on its huge bond-buying program.

Interest rates, it turns out, did nothing of the sort. If the smart money doesn’t look outright dumb, at the very least it’s not looking so smart.

On Tuesday, the benchmark 10-year Treasury stood at 1.97 percent, more than a percentage lower than the 2.98 percent it was yielding a year ago after a big run up during the last six months of 2013, market data charts indicate.

David O’Malley, CEO of Penn Mutual Asset Management, said the amount of the drop in rates since the beginning of last year “came as a surprise,” although the fact that rates are low and remain low are not surprising.

U.S. benchmark interest rates are still very low by historical standards, but they are yielding more than government securities in other countries.

With the U.S. posting strong economic growth, falling unemployment, a shrinking deficit, a hardening dollar and a strong stock market, global investors prefer investing in U.S. debt than in debt securities issued by other governments, driving up bond prices.

“If you have money in a pension plan, and you need money in as risk free (an investment) as possible, if you look around the world, what government are you go to give it to?” Dan Lash, a partner at VLP Advisors in Vienna, Va., told InsuranceNewsNet.

Whole life and universal life policies are offering guaranteed growth, but reputable insurance carriers have put a floor on the interest rates they are offering policyholders — around 3 percent — “and they may even be losing money,” Lash said.

“They are not making money in that situation, but it’s more competitive than a (bank) CD,” he added.

Market observers now talk about record low interest rates finally coming to an end in 2015, which is what many were saying at this time last year. Indeed, for years now, intimating the Federal Reserve’s next move has become a full-time job.

To wit: “Good news! Interest rates will likely rise in 2015!” headlined The Washington Post’s Wonkblog Nov. 7.

“I think the Fed will raise rates and see how the markets react,” said Quincy Krosby, market strategist for Prudential Annuities, in a 2015 investment outlook webinar broadcast Tuesday.

And then, a day later: “Everyone is sure the Federal Reserve will raise interest rates this year,” writes Steve Mauzy in the Jan. 7 post on ETF Daily News. “Then again, everyone was sure the Fed would raise interest rates in 2014. It didn’t happen.”

Oops. Sorry Jim Cramer, CNBC and dozens of other market forecasts. Lash sums it up this way: “People looking into the future are usually wrong.”

So what’s a retail advisor to do?

Lash said many clients who are relying on income in this low interest rate era are using the capital gains generated by the equity portion of their portfolios, courtesy of three very good years delivered by the stock market.

The benchmark Standard & Poor's 500 index delivered an annual return of 11.39 percent in 2014, on top of a 29.60 percent return in 2013, and a 13.41 percent return in 2012.

A 10 percent return on $100,000 invested in the Standard & Poor's 500 index would allow investors to take $10,000 before taxes without touching their principal. Strong market returns relieve the pressure on the fixed income side of the portfolio.

“Markets are going up so people are pulling a larger percentage of their gains to make up for that income,” Lash said.

The hunt for higher yields is driving investors toward high yield funds, corporate debt and real estate investment trusts (REITS), which have done particularly well, he added.

Krosby, the Prudential Annuities strategist, said that as volatility ticks up money managers need to be flexible to take advantage of changes when the market turns more “opportunistic.”

Every advisor out there is asking how much of the market’s moves are due to the Federal Reserve and how much are due to economic fundamentals, she said. Toward the end of this year, she said, is when we’re going to find out.

Cyril Tuohy is senior writer for InsuranceNewsNet. He has covered the financial services industry for more than 15 years. Cyril may be reached at [email protected].

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Cyril Tuohy is a writer based in Pennsylvania. He has covered the financial services industry for more than 15 years. He can be reached at [email protected].