Is the Government Suppressing Interest Rates?

I recently traveled to Los Angeles to attend the American Funds Institutional Advisor Forum. It was a privilege to be able to attend as only 150 advisors across the United States were invited. American Funds is the largest mutual fund company in the world and has some of the best and brightest people available managing money.

Most every advisor at the forum and the portfolio managers at American Funds feel like higher inflation is the inevitable result of our excessive government spending. Higher inflation and higher interest rates march hand-in-hand.

The bond managers at American Funds indicated that the U.S. Government is purchasing 100 percent of the mortgage backed bonds that are available. Having an automatic and secure purchaser of these bonds helps the bond to be priced at a lower rate than the free market supply and demand mechanism would price these bonds.

Why would the Government under take such an action? I believe it has to do with the millions of Americans who still have variable rate mortgages and are at risk to their rates being reset higher. If the Government can assist in keeping rates low, they essentially buy time for the upcoming mortgage resets and help people stay in their homes avoiding another massive housing failure like we had last fall.

In addition to buying time for homeowners, banks hold a lot of loans on commercial real estate that are in trouble. If the banks can delay recognizing losses on these loans our Government once again buys time for our banking system to get healthy.

My prediction is that rates will stay low for the next year. However, the problem with artificially suppressing interest rates is that the long term consequences will be worse than they otherwise would have been. Like a ball pushed under water and then released, inflation will eventually pop out at a high level.

I have redesigned my traditional portfolio allocations to include a substantial inflation hedge. It is not urgent that everyone convert immediately, as I feel we have time. I will be introducing these portfolios to all clients in 2010.