Tags: Fed | Boosts | Rates | What's | Next?

Fed Boosts Rates – What's Next?

Friday, 23 September 2005 12:00 AM

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1. Fed Boosts Rates - What's Next?

There was no real surprise on Tuesday when the Federal Reserve announced its eleventh consecutive rise in interest rates, bringing the short-term Fed Funds rate to 3.75%.

Most investors had anticipated the move, but many were eagerly awaiting a statement from the Fed regarding just how Hurricane Katrina might have changed the future path of the economy.

Contrary to that theory, Chairman Greenspan clearly felt that the need to raise rates outweighed the risks of taking a breather.

"The widespread devastation in the Gulf region, the associated dislocation of economic activity and the boost to energy prices imply that spending, production and employment will be set back in the near term," the Fed said.

Much of that inflation is associated with food and energy. Take those two factors out of the equation and consumer prices are only running at a more reasonable 2%.

Seven of the 12 regional Federal Reserve governors asked for an accompanying hike in the Fed's discount rate. That's the rate at which Federal Reserve member banks lend to each other. It's just possible that the individual governors want to wait for a clearer picture before boosting rates further.

2. U.S. Savings Void May Burst Housing

When it comes to Americans and their savings, the red flags are everywhere - and the fallout could have far-reaching effects on both the housing market and the U.S. economy as a whole.

First the bad news.

June 2005 saw the largest hike in the U.S. consumer credit rating (8.2% or $14.5 billion) in a year. That means households have borrowed more than they paid off in a given period. Worse, the personal savings rate fell to 0%, the lowest since the post-9/11 consumer spending binge in October 2001 and the second-lowest since the Great Depression.

Economists say that the decline of the savings rate to zero is leading to increased concern regarding consumers' ability to maintain current spending levels. Consumer debt has been growing about twice as fast as personal income over the past five years.

And the news doesn't get any better regarding Americans and their long-term savings habits.

Hewitt Associates reports that despite the growing need for employees to save for retirement, a significant number of workers participating in 401(k) plans "cash out" of the investment vehicles once they leave their company.

Hewitt's study of nearly 200,000 workers who participated in their 401(k) plans found that 45% elected to take a cash distribution after they left their jobs. The remainder either kept their savings in their current employer's 401(k) plan (32%) or rolled the money over to a qualified IRA or other retirement plan (23%).

"Our findings show that too many workers are not looking at their 401(k) savings as long-term in nature, but are instead using termination of employment as an opportunity to spend this money," says Lori Lucas, director of participant research at Hewitt  Associates. 

"With fewer workers tending to remain at one company until retirement, employees may become ‘serial consumers' of their 401(k) savings, which can have serious consequences when it comes to their ultimate ability to reach their retirement goals."

Some economic observers say that that Americans' poor savings habits could translate into big trouble for the housing market.

Gary Shilling, writing in the September 15 edition of Forbes, says that there is a strong correlation between residential real estate and Americans' low savings rate.

Shilling writes: "Leaping house prices make consumers feel wealthy so they save less and borrow more. Extracting money from their homes when they either refinance or move and take out a bigger mortgage, all too many homeowners use borrowed funds to make up for their declining incomes and huge energy bills."

Shilling points out that Baby Boomers don't have nearly enough money saved up to sustain them through retirement, and he takes a sledgehammer to the notion that rising home values will bail them out in retirement.

He says that younger Americans won't be there like they were in the 1990s to buy increasingly expensive homes from the Boomers. And that could leave millions of Americans holding the bag.

"Prices will get so high that potential buyers will stand aside and nervous speculators will dump their properties on the market," says Shilling.

"Already the supply of existing housing for sale is jumping. Despite the post-Katrina investor enthusiasm, housing-related stocks are on borrowed time. Homebuilders and building suppliers, mortgage lenders, mortgage insurers, appliance makers and do-it-yourself retailers eventually will all suffer.

He also says that lower stock values will fuel a larger crash in the housing market, thus ending the 25-year-long U.S. consumer borrowing and spending binge.

Forced to beef up their savings, American consumers will keep their pocketbooks closed, putting a dent into the revenues of countless industries - such as credit card issuers, car makers, cruise lines, airlines and hotels - as customers stay away.

Says Shilling: "This is a dire forecast. Still, a severe nationwide break in house prices could destroy enough net worth and spawn a big enough financial crisis to shift the good deflation of excess supply I foresee to the bad deflation of deficient demand." 

3. Diversified Buffett Unscathed by Katrina

Serious Warren Buffett observers - and they are legion - are going over Berkshire Hathaway's portfolio with a fine-tooth comb these days. They're looking for stocks that could damage the Buffett portfolio after Hurricane Katrina.

Business Week reports that about 60% of operating earnings at Berkshire Hathaway are from insurance-related businesses like General Re, GEICO and National Indemnity. Each could suffer steep losses, the magazine says. But Buffett has been there before.

The BW article says: "In the third quarter of 2004, Berkshire had an $816 million after-tax loss from Florida hurricanes. Overall, net earnings fell 37% then, to $1.1 billion. Katrina could be crueler. But Berkshire, like other insurers, is coming off four years of rising prices. It has a capital base of $88 billion. Katrina losses are "likely to be a mosquito bite for Berkshire," says Morningstar senior stock analyst Dreyfus Neenan.

To cushion the blow from Katrina, Buffett may be able to count on vast holdings in companies like Benjamin Moore, carpet maker Shaw Industries and Clayton Homes, the leading maker of manufactured homes in the United States.

"All could benefit as cities rebuild," the magazine goes on to say. "FEMA has ordered 1,800 Clayton mobile homes to house evacuees. Clayton cut prices for the government but expects a small profit. Finally, if energy remains pricey, Berkshire has a 1.3% stake in oil producer PetroChina."

As Business Week points out, being super-rich means never having to put all your eggs in one basket.

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5. WSJ: Dividend Funds Fueling Japan Bull

Is the two-decade-long Japanese bear stock market on the rebound?

The Wall Street Journal thinks so.

In its September 20th edition, staff reporter Yuka Hayashi says a new wave of dividend-paying mutual funds is fueling a market resurgence in Japan this fall, bringing what Hayashi refers to as Japan's "stubbornly bearish individual investors" back to the stock market.

He writes: "For the past decade-and-a-half, most ordinary Japanese shunned stocks, disillusioned by a market that has lost two-thirds of its value since its peak in 1989. Many Japanese thought stocks were for speculators, and stuck with safer investments like bank deposits and government bonds. In Japan, only 9% of household financial assets are invested in stocks or mutual funds, according to Bank of Japan statistics, compared with 46% in the U.S."

But the trend is a recent one, Hayashi reports.

Through August 2005, retail investors sold $26 billion more in stock than they bought this year. The Nikkei 225 Stock Average managed to rise 13% for the year despite the heavy selling. The WSJ credits foreign investors for the upward spike in Japanese stock prices.

Now Japanese investors are warming up to a new type of mutual fund - a high-dividend-paying vehicle that provides steady checks to eager investors. These new funds are quite similar to U.S.-based equity income funds, the newspaper says.

"Companies including Nomura Securities Co.'s Nomura Asset Management and Fidelity Investments have rolled out such funds this year, collecting billions of dollars. One popular fund even had to suspend customer orders, as investors poured in money faster than it could handle," reports the Journal.

The paper says that 26 new dividend-paying funds have been rolled out in the Japanese market this year, hauling in 960 billion yen ($8.6 billion in U.S. funds).

Though they have had little impact so far (such funds have only invested 165 billion yen in the Japanese stock market so far in 2005 - compared to $50 billion from foreign investors) the funds' influence could be far-reaching, Hayashi writes.

"Yet any sign of increased investment by mom-and-pop buyers is important," he says. "Attracting individuals will be key to keeping the Japanese stock market stable and helping to maintain its current upward momentum. The Nikkei 225 has soared nearly 20% to 12958.68 since mid-May"

"There aren't enough long-term domestic investors - and that tends to leave the market foreigner-oriented," John Vail, Japan equity strategist at J.P. Morgan Securities in Tokyo, told The Journal.

"It's better to have solid domestic equity investors."


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(Headlines - scroll down for full stories)1. Fed Boosts Rates - What's Next?There was no real surprise on Tuesday when the Federal Reserve announced its eleventh consecutive rise in interest rates, bringing the short-term Fed Funds rate to 3.75%. Most investors had...
Friday, 23 September 2005 12:00 AM
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