The times are changing. Americans, surprised by lower interest rates, have been quickly shifting their money out of low-yielding money-market funds and bank certificates of deposit.
Beneficiaries of this changing environment have been bond funds, which provide greater yield, and stock funds, which offer greater adventure.With the nation slowly grinding its way out of recession, it's expected that recent interest-rate cuts will hold firm. They're unlikely to decline very much more through year-end.
This stable outlook certainly isn't exciting or flashy. But it does mean that average folks should be able to borrow at reasonable rates for a while. Furthermore, the decline in the prime lending rate at banks to 8.5 percent, the lowest since 1987, is a boon to the pocketbooks of consumers with loans already tied to the prime.
As far as Wall Street is concerned, the combination of economic recovery, modest inflation and low interest rates should continue to bode well for the stock market.
"The long bond (recently just over 8 percent) should go no lower than 8 percent this year, but could go to 7.5 percent next year," predicted Maury Harris, chief economist for PaineWebber Inc. "Investors should start extending the durations of their bond holdings somewhat in order to pick up some additional yield."
He's bullish on the stock market, which he believes could be up another 10 percent in the next 12 months. Quality growth stocks in the food and drug industries would also be smart moves right now, he believes.
Such activity is already under way, since savvy investors don't need to consult economists to grasp the reality of declining rates. In March alone, a net flow of $3.6 billion moved into bond funds, the most for any month since March 1987.
Low rates are luring investors into stock mutual funds as well, with a strong inflow of funds that has the industry glowing and looking toward a record year.
"We've probably reached the bottom on short-term interest rates, with at most another quarter-of-a-point decline, and that only if it's mandated by a weak economy," predicted James Annable, chief economist at First National Bank of Chicago, who expects long-term rates might go up a bit and therefore currently isn't bullish on long-term bonds. "If you want to borrow for any purpose, such as refinancing a mortgage, this is definitely the time to do it."
Of course, a monkey wrench would be thrown into this scenario if a stubbornly sluggish economy doesn't respond in the second or third quarter of the year, as is currently expected by so many pundits.
After weeks of cajoling, President Bush was able to convince Federal Reserve Chairman Alan Greenspan that the recession won't end without lower interest rates.
But the road back to a strong economy may be more arduous than some expect. Recently improved unemployment figures don't seem to be supported by payroll figures, and the jump in consumer spending and confidence following the Persian Gulf war seems to have subsided.
"There is a possibility that short-term rates could head lower to some degree, if the economy won't revive quickly," said Thomas Poor, portfolio manager of the Boston-based Scudder Short Term Bond Fund. "Longer-term rates, on the other hand, respond basically to inflationary expectations, and the outlook for inflation isn't quite as clear as the outlook for short-term rates." He sees long-term Treasuries slipping as low as 7.5 percent by year-end.
"We still expect the recession to be shallow and that we'll be coming out of it in the second quarter," said Charlie Smith, portfolio manager for the Baltimore-based T. Rowe Price New Income Fund. "Our bond funds have been pulling in considerable assets basically because money-market fund and certificate of deposit yields are low, and bond prospects are better."
But be cautious. While Smith said he "can live" with two- to three-year maturities, he definitely wouldn't take the risk of getting into a 30year bond to obtain an 8 percent yield with the future still uncertain.
"I consider it a dangerous time to extend maturities too far, because we can't be absolutely certain about the end of recession or interest rate moves," warned Smith, who expects short-term rates could be one-half to one percent higher by year-end, while long-term rates rise to 8.5 percent or 8.75 percent.