Cool as a cucumber. That's how Federal Reserve Chairman Ben Bernanke comports himself.
Yet the nuance in his words can quickly be transformed to fire or ice when heard by nervous investors around the globe. His acknowledgment that U.S. economic weakness could cause the Fed to consider lowering rates in the future, not raise them, is capable of propelling markets to greater heights.
The risk of inflation, on the other hand, with Bernanke thinking out loud about how it is still more likely that rates will be raised than lowered, can traumatize the markets. Like his predecessor, Alan Greenspan, who depicted inflation as an ever-lurking bogeyman, Bernanke plays both ends against the middle to keep everything moving smoothly.
In this effective balancing act, he reveals more about future intentions than Greenspan typically did. Bernanke seems relaxed and composed, having prepared for this job for years and now coming into his own.
When weighed on the current economic scales, possibilities appear tilted toward lower interest rates sometime this year. At least that's the side of Bernanke logic where cooler heads place the most bets right now.
"While I expect interest rates to go upward over the next five to 10 years, in the short term they've peaked and will go lower the next six months," said Kathleen Gaffney, one of the portfolio managers of Loomis Sayles Investment Grade Bond Fund, which had a total return of 9.4 percent the past 12 months. "The Fed will start to ease rates close to the second half of the year--a rate cut or two--driven by a cooling U.S. economy and weakness in housing."
Her fund's three-year annualized total return of 6.9 percent, five-year annualized return of 10.4 percent and 10-year annualized return of 9.1 percent rank near the top of all intermediate-term bond funds in Morningstar Inc. data. It has 131 bond holdings, more than one-third of assets of AAA quality.
"Right now, interest rates are fairly low, so if you're looking for higher returns, you have to think internationally," said Gaffney, who has been with Loomis Sayles for more than two decades. "People have started to do that on the equity side, but are less likely to do that on the fixed-income side."
The fund has nearly one-fourth of its portfolio in foreign government and corporate bonds, with Canada and Mexico a large chunk of that.
Others are expecting a Fed rate cut.
"You will see short-term rates decline modestly in August or September, as the economy leads the Federal Reserve to reduce its target for the federal funds rate from 5.25 percent to 5 percent," said Hugh Johnson, chairman of Johnson Illington Advisors LLC in Albany, N.Y. "Fixed-rate mortgages are likely to be very stable since they are sensitive to longer-term rates in the Treasury market."
Cash will no longer be king in this environment and, with the degree of economic uncertainty, higher-quality bonds make the most sense. "It has been a good strategy to go short and hide in cash, but as the economy slows down to 2 [percent] or 2.5 percent growth, inflation will come down," said William Hornbarger, fixed-income strategist for A.G. Edwards & Sons Inc., who remains confident the Fed will cut short-term rates a couple of times in 2007.
The big investment story is that those invested in six-month certificates of deposit, money markets and one-year CDs will face some reinvestment risks after the Fed lowers interest rates, Hornbarger said.
According to Morningstar, the top intermediate-term taxable bond funds in total return for the past 12 months were recently:
-- HSBC Investor Intermediate Duration Fixed Income "I," 11.1 percent.
-- AllianceBernstein Bond Fund Corporate Bond "A," 10.5 percent.
-- Delaware Diversified Income Fund "A," 10.1 percent.
-- Loomis Sayles Investment Grade Bond Fund "Y," 9.4 percent.
-- Managers Fixed Income Fund "A" Fund, 9.3 percent.
"When it comes to bond funds, investors should look for a manager who adds value whether rates are up, down or not moving at all," said Paul Herbert, fund analyst with Morningstar.
You also want a manager with reasonable things to say about the market's current risk level and should look at how that manager performed in past periods of market stress, he added.
Every market is different. Right now, for example, investors aren't being paid much for assuming higher risk and chasing yields in corporate bonds.
Top intermediate national tax-exempt municipal bond funds in 12-month total return are: -- State Farm Municipal Bond Fund, 6.9 percent.
-- Vanguard High-Yield Tax-Exempt Bond Fund, 5.8 percent.
-- YieldQuest Tax Exempt Bond Fund, 5.8 percent. -- Phoenix Insight Tax-Exempt Bond "I," (HXBIX), 5.4 percent. -- Elfun Tax-Exempt Income Fund, (ELFTX), 5.4 percent.
Experts generally give Bernanke high marks because he isn't the all-out inflation hawk that many had anticipated. Gentle Ben is his own man and not trying to mimic Greenspan's resolve.
"Bernanke is doing a commendable job in a difficult environment," Johnson said. "He has definitely taken into consideration the problems facing the economy as much as he has considered some upward pressure on prices."
Andrew Leckey is a Tribune Media Services columnist.