Back in mid-October, I launched a new portfolio for income investors because I thought such investors could use some help in a very tough market environment. At the time, yields weren't very tempting: In fact, if you looked at the 4.5% yield on the 10-year Treasury note, they were downright disappointing. And as if that weren't enough, the Federal Reserve was firmly locked into a series of interest rate hikes well into 2006 that would knock down the price of any bond an income investor bought. Two months later, a lot has changed. But not for the better. The 10-year Treasury note still yields a low 4.5% -- 4.52% on Dec. 1, to be exact. But now there's even less reason to go long since, thanks to the Fed, short-term rates have moved up so that two-year and five-year Treasury notes yield almost as much as a 10-year issue. Furthermore, the Fed looks likely to raise rates two or three more times; consensus expectations call for an end to the rate hikes with the fed funds rate at 4.5% or 4.75% vs. the current 4%.
More Uncertainty in 2006
But what happens after that is even more uncertain than it was two months ago. Will the Fed go on hold for the rest of 2006 after those presumptive increases? Or will the central bank be forced to actually reverse course and cut interest rates in the second half of the year as the economy weakens? Typically, when the yield curve inverts -- with short-term rates climbing above long-term rates -- as it is near to doing, it signals a potential economic recession. Outgoing Fed Chairman Alan Greenspan says not this time, but hey, he'll be playing tennis when this pudding gets eaten. So, right now, income investors are facing low yields, near-term rate hikes that will drive down the price of bonds and other income vehicles, plus increasing uncertainty about the direction of interest rates for the second half of 2006.