Bond Strategists: Morgan Stanley's Roach Sees Fed Going to 5.5%
Bond Strategists: Morgan Stanley's Roach Sees Fed Going to 5.5%
April 26 (Bloomberg) -- Stephen Roach, Morgan Stanley's chief economist, said the U.S. Federal Reserve may not stop raising the key interest rate until it's as high as 5.5 percent to control the ``housing bubble'' and a widening current-account deficit.
The economy is ``balanced on the head of a pin of unsustainably low real interest rates,'' wrote Roach, 59, a former researcher at the Fed, in a report published yesterday from New York. ``The Fed needs to play the role of the tough guy that is required of a truly independent central bank -- taking the proverbial punch bowl away when the party is in full swing.''
The Federal Funds rate, now at 2.75 percent, was most recently at 5.5 percent in March 2001, the month the U.S. economy entered recession. The 10-year Treasury note yielded 4.81 percent on March 19, 2001, a day before the Fed cut the benchmark rate to 5 percent. It yielded 4.24 percent at 5 a.m. New York time today.
The deficit in the U.S. current account, the broadest measure of trade, widened to a record to $187.9 billion in the fourth quarter last year. U.S. house prices jumped 11.4 percent in March from the same period a month ago, the biggest 12-month gain since December 1980, according to a report from the National Association of Realtors yesterday.
There are ``distortions and imbalances evident in the U.S. today,'' wrote Roach. ``That's especially true of low saving rates, the housing bubble, high debt loads, and a runaway current account deficit.''
Fed Governor Donald Kohn said April 22 that the level of real- estate prices was `lofty' and gains may slow as interest rates rise and wage growth cools. Fed policy makers have lifted the target rate for overnight loans between banks to 2.75 percent from 1 percent since June last year. The Fed next meets on May 3.
Inflation
Kohn said the 22 policy makers ``have not yet finished'' lifting the benchmark rate to curb inflation. The core personal consumer expenditures index, used by the Fed, probably rose 1.7 percent in March from a year earlier, compared with 1.6 percent in February, according to the median estimate of eight economists surveyed by Bloomberg. The report from the Commerce Department in Washington will be published April 29.
The median of 59 forecasts in a Bloomberg survey published on April 8 is for the Fed funds rate to end the year at 4 percent. Morgan Stanley, the world's second-largest securities company, also predicts the rate will be at 4 percent by year-end before rising to 4.5 percent by the middle of the 2006.
``Given the excesses that now exist, it may require a Federal funds rate that needs to move into the restrictive zone - possibly as high as 5.5 percent,'' wrote Roach. ``Yes, this would cause an outcry.'' Roach wasn't immediately available for comment today.
`Get Real'
U.S. Treasury notes fell for the first quarter in three in January to March as signs of faster inflation damped speculation the Fed will slow the pace of interest-rate increases this year.
``The day is close at hand when U.S. monetary policy must get real,'' wrote Roach.
Morgan Stanley's Joachim Fels, chief fixed-income strategist at the bank, said March 18 that the best may be over for U.S. government bonds amid signs of accelerating inflation in the U.S. Since reaching this year's high of 4.64 percent on March 22, the yield has dropped 40 basis points to 4.24 percent today.
To contact the reporter on this story: Jake Lee at jlee127@bloomberg.net
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