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Fed rate cuts predicted

The Baltimore Sun

Cool as a cucumber. That's how Federal Reserve Chairman Ben S. 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 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, can traumatize the markets.

Bernanke seems relaxed and composed, having prepared for this job for years and now coming into his own.

"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," says Kathleen Gaffney, one of the portfolio managers of Loomis Sayles Investment Grade Bond Fund, which had a total return of 9.4 percent for 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," Gaffney said.

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.

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."

"It has been a good strategy to go short and hide in cash, but as the economy slows down to 2 or 2.5 percent growth, inflation will come down," said William Hornbarger, fixed-income strategist for A.G. Edwards & Sons Inc., who remains confident that 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.

"Bernanke is doing a commendable job in a difficult environment," said Johnson of Johnson Illington.

Andrew Leckey writes for Tribune Media Services.

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