prices continue to rise, that has the greatest impact on the lower end of the consumer spectrum where people make less money. That’s where the risk lies. The Fed will just continue to tighten, as we believe, until the end of the year. It is the rising energy costs that will then contribute to the reduced spending of the consumer overall.
While everyone is saying there is a housing bubble, it’s on a more localized basis. It’s here in New York. It’s in the bigger cities. It’s not in middle America. Local housing bubbles come and go. Nationally, we don’t believe that there is a housing bubble. We think that housing is going to be solid going forward.
Payne: Energy is definitely a threat. When it first broke out of its historic trading range, it was because there was a terrorist premium involved. Then, of course, it was because demand from India and China started driving it. There is some validity to that, but there is also a big game being played. Historically, when crude oil gets to a certain price, people stop buying it. The supply and demand balance always shifts, so I think $60 is a magical number, but it’s a number that bothers me. If oil stays above $60 for three to six months or longer, it becomes much more of a speed bump.
Phelps: Everybody keeps expecting rates to go higher but they haven’t. I think a lot of that is due to global liquidity. It’s obvious that 4% interest looks pretty good to a lot of people around the world, so they are buying it.
Johnson: Global liquidity conditions are very loose, and most countries, the notable exceptions being the U.S., the U.K., Canada, Australia, and New Zealand, need a place to invest their dollars. So foreign purchases have certainly been contributing to low interest rates.
At the same time, under the leadership of Alan Greenspan, the Federal Reserve has increased investor confidence. So, the inflation premium that we are used to seeing as investor demands on long bonds increase just isn’t there because people believe the Fed is goi
ng to be much more effective in achieving its two main objectives: promoting economic growth and price stability.
We believe, however, as we go into 2006 and Greenspan’s term expires, the new Fed chairman will be the wild card. I don’t know if he or she will be as effective as Greenspan.
BE: Are there any triggers that might signal the economy might move forward or slip back?
Johnson: Investors should pay attention to the Fed and interest rates. Interest rates have always been a key indicator for economic activity. If rates start to increase, we become a little bit more defensive by shortening up the duration of the average maturity in our portfolios. In addition, we’re reducing the credit risk in our portfolio. Going forward, in the bond and equity portfolios, the key to generating good results is going to be security selection—buying good, solid companies.
BE: So, should investors with bond mutual