Personal Finance Advice

As it has become increasingly difficult to find investments with positive gains, municipal bonds have begun to surge to the forefront. The yields on muni’s have become comparatively attractive in recent months due to a number of factors.

Although a shaky stock market tends to have investors fleeing into the warm embrace of the bond market, things are a little different this time around. The bond market is having it’s own little crisis at the moment.

Bond insurers are reeling from the fallout of the sub prime mortgage collapse with many firms in that industry having lost or are in danger of losing their AAA ratings. This has in turn added an aspect of volatility to a normally placid market.

This added uncertainty along with renewed fears of inflation, due to the Fed’s recent aggressive moves, have sent bond prices falling recently and yields up. These higher yields coupled with their tax free status have led many financial analysts to extol their virtues.

If anything, the recent troubles in the bond market have made muni’s even more attractive. While the short term risk has grown considerably, the long term risks are negligible.

This is due to the fact that historically, muni’s have a miniscule default rate, less than 0.01%. Even non AAA rated muni bonds have a lower default rate than their AAA rated coporate counterparts. As a long term investment, it’s one of the safest bets around.

The stock market made big gains last week on the strength of the recent rate cuts, only to give them back at the start of this week as more bad news on the economic front was released.  A major contraction  in the massive U.S. service sector led to a large sell off on Wall Street.

While The Fed had been much more aggressive in it’s monetary policy recently, inflation is still a major concern.  Philadelphia Fed President Charles Plosser earlier today stressed the hazards of rate cutting.

“Ignoring inflation during times of economic weakness risks undermining our ability to achieve economic growth over the long run.”

“It [monetary policy] cannot solve the bad debt problems in the mortgage market. It cannot reprice the risks of securities backed by subprime loans. It cannot solve the problems faced by those financial firms at risk of being given lower ratings by rating agencies, because some of their assets are now worth much less than previously thought.”

While the economy has been slowing recently, inflation numbers have been higher than expected and economists will be keeping on close watch on the January data.  On a positive note, while the price of oil broke the $100 barrier for the first time last month, it has been trading at under $90 recently.

Nonetheless despite the renewed inflationary concerns, many analysts believe the Fed will cut rates once more in the upcoming weeks.  They point to the fact that there has been little or no signs of wage inflation since the rate cutting campaign began last fall.

While many Americans have been afraid of a recession for months, the economy has been holding up fairly well but that’s starting to change. Gross Domestic Product or GDP has continued to grow and new jobs were being created all through the housing slump and the subsequent sub prime fiasco.

Last quarter the economy grew by only 0.6 percent, showing signs that the problems in the financial markets may finally be catching up with it. January also saw the first job loss in the economy in almost 5 years.

The Federal Reserve has decided to step up it’s monetary policy initiatives, cutting interest rates twice in an eight day span. These moves pretty much signaled to the world that the Fed is much more worried about the economy than concerns over inflation or exchange rates.

While in past articles I have raised these concerns myself, I must conclude that it’s the right move for this situation. The credit markets are in shambles and that has to be the number one priority right now.

While this does put an upward pressure on inflation I don’t believe it will be significant compared to the skyrocketing of food and energy prices that we saw last year. The price of a barrel of oil had risen by 60% before the Fed even started it’s rate cutting campaign.

At this point I believe interest rates could go at least another half a percent lower, possibly more. The biggest challenge for the Fed will be to get other central banks to agree to coordinate with it’s moves as fears of a recession are not confined to this country. Economic growth is slowing around the globe and if U.S. economy slips into a recession the rest of the world won’t be far behind.