For some time, we have forecast that inflation would return to relatively normal levels in 2011. In fact, we expect core inflation (inflation excluding food and energy) to rise from its near-zero year-over-year rate to closer to 2%. We expect high unemployment and sluggish growth to continue to cap inflation, likely offset to some extent by upward pressure on prices from the weak dollar, some wage growth, “imported inflation” in and from the emerging markets, and strong commodities market.

‘Flight to Quality’ Impact on Yields

In light of these factors, we’ve been suggesting that the range for bond yields this year (using the 10-year Treasury note as our basis) would range from 3% to 4%, finishing the year near the high end of that range. Right now, the markets are warily eyeing sovereign debt defaults in Europe that could reignite the debt crisis there, its impact possibly spilling into the US economy. Not surprisingly, this scenario has triggered a “flight to quality” that has pushed yields near 3%, the low end of our range. When adjusted for inflation (overall or “headline” inflation exceeds 3%), yields on 10-year notes are effectively negative. We do not think yields this low are sustainable.

But when will that change? The short end of the yield curve remains anchored near zero, courtesy of the Federal Reserve. Earlier this year we anticipated that the Fed might begin raising rates by the first quarter of 2012. In light of the slowdown, it may be tempted to wait even longer, perhaps until the middle of next year. Depending on how the economy develops, we may consider moving from short-term bond portfolios to slightly longer durations.

Choppy Equity Markets

We had forecast only moderate equity returns for 2011. We are sticking to this view. By the end of May, the stock market had gained about 5%. We don’t anticipate the S&P 500 exceeding 1400 in 2011, translating into a total return of roughly 6% to 8%. We anticipate a range-bound and increasingly choppy market as the year wears on. This is an environment in which it pays to buy on the lows and sell down on the peaks.

Our “buy” threshold has been the S&P 500 at 1250, while we continue to view 1380-1400 as a good point at which to consider selling. The stock market is holding up reasonably well, probably reflecting the growing belief that a third round of quantitative easing has become more likely.

There is no question that the economy is sluggish. Confidence is down. Job growth is frail. Wall Street is cutting GDP estimates. Home prices are in a double dip. Auto sales are slowing. And the pace of the slowdown has been both swift and alarming. All this said, however, we are not double-dip-believers. Monetary policy remains relatively easy and, while the “fiscal spending thrust” that supported GDP growth out of the trough is beginning to wane, we do not expect the federal government to change its spending ways drastically in the near term. At least as important are oil prices. The increase in oil prices in the last year removed about as much purchasing power as the payroll tax holiday put in. We anticipate that oil prices will fall as the world economy slows.

Watching the Risks

There is plenty to think about: the (possible) end of quantitative easing, the unsustainable situation in Europe, our own debt problems (as a highly partisan and split Congress confronts the need to raise the US debt ceiling), fiscal issues at the state and local government level, the creeping return of questionable credit practices, uninspiring valuations, heightened geopolitical uncertainty, the ailing housing market, the weak jobs market, China, etc., etc.

We continue to believe that investments in hard assets and emerging markets make sense in portfolios for the longer term. We also see other opportunities. Of particular note is the strengthening outlook for capital spending. As labor productivity peaks, we think it likely that companies will upgrade plant and equipment, fueling economic growth. Similarly, we anticipate ongoing, though slow, improvement in the labor market.

As always, we attempt to balance shorter-term developments in the financial markets with our longer-term views and investment objectives. We adhere to an investment discipline that prevents us from overreacting to dramatic, short-term market movements. We encourage you to do the same.

This article was prepared by Contango Capital Advisor’s Investment Strategy Group. Contango Capital Advisors is an affiliate of Zions Direct.

The information contained in this article is not intended to be and should not be construed as tax advice. It is not intended or written to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code. Contango Capital Advisors does not engage in the business of providing tax advice and estimates should not be construed as such. Clients should consult their tax professionals regarding their personal situation prior to taking any action based upon this information. CCA0611-0093R

One investment “rule of thumb” that has traditionally developed is smaller investors are usually late to the game…and thus expose themselves to higher levels of risk when a market bubble leaks, bleeds, or bursts. Such a time could easily be approaching in regard to the purchase or continuing ownership of bonds.

Tens of thousands of smaller investors have grown frustrated with the dismal overall performance of most stocks (also known as equities) during the past decade. Many of these investors in the past would have simply shifted some of their investment funds to financial institution savings accounts and certificates of deposit.

Many investors like the ability to sleep at night, knowing that deposits of up to $250,000 are guaranteed by the FDIC. Most recognize that while interest rates are extremely low, inflation pressures are also historically low.

For other investors, the low interest rate on such savings accounts and CDs has led them to seek higher returns. Bonds…especially U.S. Treasury notes and bonds…have been extremely popular, whether owned as individual securities or as part of a bond fund.

The Investment Company Institute reports that from January 2008 through June 2010, outflows from stock mutual funds totaled $232 billion. During the same time period, bond funds saw an enormous $559 billion inflow (The Wall Street Journal).

For those who shifted money into bonds or bond funds earlier this year, the returns have been attractive. For those who are considering such an investment now, the risks are extremely high.

The Other Risk

Human nature suggests that thousands of average investors who bought bonds earlier this year have boasted to their families and friends about the attractive returns they have generated by buying longer-term U.S. Treasury notes or bonds. As their buttons are bursting from their chests, they also note that these returns have been generated from investments that are U.S. Government guaranteed…

…They are somewhat correct

…and they are woefully misinformed

For example, an investment of $100,000 into the 2.625% 10-year maturity U.S. Treasury note due on 8/15/2020 (bought at face value or par) is guaranteed by the U.S. Government as to semiannual interest payments of $1,312.50 on February 15 and August 15 of each year. In addition, you will receive back your $100,000 principal investment on August 15, 2020.

This security has no “credit” risk. Believe it or not, debt issued by the U.S Government to finance enormous budget deficits is still considered the safest, most liquid (marketable) investment in the world. It is this assurance that helps people sleep at night.

However…and this is a BIG however…the investment is still subject to “market” risk. The value of the bond fluctuates daily, based on the general movement of interest rates.

Since the 1950s

The 10-year U.S. Treasury note yield (investment return) at mid-day on Tuesday, August 24 was 2.53%. The 30-year U.S. Treasury bond yield was 3.62%. With the exception of a few weeks very late in 2008 and very early in 2009 at the height of the global financial crisis, current yields are the lowest in more than 50 years, since the 1950s! The same is true for 15- and 30-year fixed-rate conventional mortgages, which averaged 3.90% and 4.42%, respectively, last week.

Long-term interest rates have fallen sharply in recent months because of high anxiety about slowing global and U.S. economic growth, as well as high anxiety about possible default by Greece and other southern European nations. Possible deflation in coming years, as well as stocks going nowhere in recent months have also contributed to rising bond prices…and lower yields.

Barring another global economic or financial meltdown, or other major hits to the U.S. and global economies, such long-term interest rates are not likely to move much lower. Yes, some suggest we could see a period of deflation in the U.S. economy, as discussed in last week’s issue of the Tea Leaf. Under such a scenario, long-term interest rates could move even lower.

The Party’s Over?

However, most economic forecasters and financial market professionals suggest that the amazing and largely unexpected decline in long-term interest rates has about run its course. They would suggest that the primary direction of long-term interest rates later this year and throughout 2011 is to somewhat higher levels. They point to the fact that while the U.S. economy has definitely slowed down in recent months, the odds do not favor a return to recession.

Note: We do know that the first U.S. Commerce Department estimate of a 2.4% real (after inflation) annual growth pace during 2010’s second quarter could be roughly cut in half when the first revision is released on Friday of this week. The consensus forecast for U.S. economic growth during 2010’s final quarter and for 2011’s first half is near a 2.5% annual growth rate.

Forecasters might note that there have been 33 official recessions since 1850, and only three times has the economy fallen back into negative growth within a year, according to the National Bureau of Economic Research, the official scorekeeper for the U.S. economy(www.Bloomberg.com).

…but I digress

The point is that a meaningful rise in long-term interest rates in coming months or quarters—when and if it does occur—will lead to sizable investment losses for many previous (and especially) new investors into direct bonds or bond funds.

Two Risks

Financial market emotions can turn on a dime. At some point, high anxiety about $1,000,000,000,000 and larger annual budget deficits could (or will) return. All of this excessive government spending must be met with borrowed money…much more borrowed money. Longterm interest rates could easily rise.

For example, if 10-year U.S. Treasury note yields were to rise one percent in coming months, simply back to the still low 3.53% level of last Spring, an investor buying notes or bonds today would have a 9% loss of principal should they need to sell…a loss of $9,000 on a $100,000 investment.

A similar 1.00% rise in the 30-year U.S. Treasury bond yield to a still low 4.62% would create a principal loss of nearly 20% for an investor buying the long bond today and needing to sell later…a loss of nearly $20,000 on a $100,000 investment! An investor in a long-term bond fund would see similar losses, while an investor in a shorter maturity bond fund would lose less…

Understand that a U.S. government guarantee applies to credit risk only…

…market risk is a whole ‘nother animal.

Jeff Thredgold is an economic consultant to Zions Bank

Featured in the 24 August 2010 issue of Jeff Thredgold’s Tea Leaf newsletter.

WASHINGTON (AP) — Treasury Secretary Timothy Geithner says the Obama administration will move quickly to implement new financial regulations while eliminating those that are outdated.

Geithner says the administration has no desire to simply layer new rules on top of those in place that are not working.

Geithner’s comments came in excerpts Treasury released in advance of a speech he is scheduled to deliver Monday, August 2, afternoon at New York University. The address will launch an effort by Treasury officials to explain how the administration will be implementing the overhaul bill that President Barack Obama signed into law on July 21.

Copyright 2010 The Associated Press. All rights reserved. This material may not be published, broadcast, rewritten, or redistributed.

One more month…one more exceedingly painful U.S. employment report

We have now had seven consecutive terrible job reports since the American consumer was told “the sky was falling” last September 18 by Federal Reserve Chair Ben Bernanke and then-U.S. Treasury Secretary Paulson. It was on that day that this dynamic duo emotionally and very publicly asked the U.S. Congress for $700,000,000,000 to fix financial markets.

That request, and the up-and-down discussion within the U.S. Congress during the following week, simply scared the American consumer to death. The consumer stopped spending…companies of all sizes adopted a “shoot first, ask questions later” approach to layoffs…and the economy dropped quickly. The rest, as they say, is history.

U.S. Employment Growth

The Numbers
Total U.S. employment fell by another 663,000 net jobs during March, matching economists’ consensus view. February’s previously reported loss of 651,000 jobs was not revised. That’s the good news. However, January’s previously reported (and previously revised) loss of 655,000 jobs lost was revised to show a loss of 741,000 jobs during the month—the worst month for job losses in 59 years. April losses will be ugly as well.

Equally painful was the surge in the nation’s unemployment rate from 8.1% in February to 8.5% in March, the highest level in 25 years. By comparison, the jobless rate was 5.1% just one year ago. The jobless rate averaged 4.6% in both 2006 and 2007 and 5.8% during 2008. An American jobless rate at or slightly above 9.5% is a real possibility within the next 9-12 months.

Economists have pointed out a handful of more positive economic statistics in housing, manufacturing, and retail sales in recent weeks to suggest that the U.S. economy is seemingly in the process of bottoming out. The consensus view of forecasting economists, as well as the collective view of the stock market, is for a return to marginally positive (yes positive!) U.S. economic growth during 2009’s second half.

We continue to expect GDP to be slightly positive during the fourth quarter. There was nothing in the March employment data to support this view, although yes, employment data is a lagging economic indicator.

Job Demise
The American economy has now lost 5.1 million jobs since the U.S. recession officially began in December 2007. Nearly two-thirds of the job erasures have occurred during the past five months alone.

As noted previously, the net loss of 3.1 million jobs during 2008 was the worst year for employment since 1945. To illustrate just how bad the first three months of 2009 have been…if no additional job losses were recorded over the balance of the year, 2009 would still be the fourth worst year since the U.S. Labor Department began tracking such data in 1939 (CNNMoney.com).

Inside the Pain
To illustrate just how pervasive and all-encompassing the current lengthy recession is, almost no employment sector is avoiding job cuts. The nation’s goods producing sector lost another 305,000 jobs during March. U.S. manufacturing was hit with the loss of another 161,000 jobs during the month, the 16th consecutive monthly decline. The nation’s embattled construction sector lost another 126,000 jobs, the 21st month in a row of cuts.

Equally dismal was the 358,000 net decline in service sector employment. The professional & business services sector lost another 133,000 jobs, while retail trade saw another 48,000 jobs bite the dust. Leisure & hospitality lost another 40,000 jobs, the finance industry lost another 25,000 jobs, and government employment declined by 5,000 positions. Only the education & health services category saw rising employment, although the net increase of 8,000 jobs was the weakest in that sector in many moons.

Better news was found in regard to the average hourly wage, which rose 0.2% (three cents) to $18.50 hourly. While the 3.4% rise over the past 12 months is hardly worth writing home about, it looks good versus consumer inflation which has been essentially zero during the past year.

More Jobless
Almost everyone knows one or many people who have seen their jobs disappear during the past 12-24 months. Prospects to replace these jobs with similar income levels are, for most, difficult. Such is the nature of a recession, especially the long and deep variety from which we are currently suffering.

A record 13.2 million people are now officially unemployed. Even more painful is the “underemployment” rate. This rate, which attracts rising attention each month, includes those who are unemployed, those who are working part-time but would prefer to work full-time, and those discouraged people who have dropped out of the labor force but would accept a job if one were offered…

…the “underemployment” rate is now 15.6%, up from 14.8% in February, and the highest since this particular measure began being tracked 15 years ago. This rate will move higher in coming months as well.

College Grads
Current job prospects for new college graduates are dicey. The National Association of Colleges and Employers forecast that employers will hire 22% fewer graduates this spring (The Associated Press).

More newly minted graduates are required to pound the pavement for jobs, rather than simply waiting for recruiters to visit their campuses. That may actually be a good thing. Since the average graduate will change jobs three times within five years of graduation, developing good job search skills now may just come in handy.

Pick Your Poison
No gender, race, or education level avoided the employment ax in March. The jobless rate for adult men spiked from 8.1% in February to 8.8% in March as traditionally male-dominant (can I say that?) sectors such as manufacturing and construction got hammered. The jobless rate for women rose from 6.7% to 7.0%.

The jobless rate for Whites rose from 7.3% in February to 7.9% in March. The jobless rate for those workers of Hispanic or Latino ethnicity rose from 10.9% to 11.4%. The jobless rate for Blacks or African-Americans actually dipped by 0.1%, but was still an unacceptably high 13.3%.

Unemployment rates for those of all educational levels also rose during the month. Those with at least a bachelor’s degree had a jobless rate of 4.3%, with the rate moving higher for those with less education. The jobless rate for those with less than a high school diploma? 13.3%!

We will get through this recession, but seeds of new growth will continue to be seen in other sectors besides and before employment.

Jeff Thredgold is an economic consultant to Zions Bank

Featured in the 8 April 2009 issue of Jeff Thredgold’s Tea Leaf newsletter.

*Artwork from Rob Sheridan under Creative Commons license at Flickr.com.

One of the things I enjoy most about my job is the interaction I have with you — our clients. Whether the interaction is face-to-face, on the phone or through e-mail, I appreciate hearing from you.

Over the past few weeks, I have received a number of questions and comments regarding Zions Bancorporation’s participation in the U.S. Treasury’s TARP Capital Purchase Program. As we have reported, in mid-November 2008, Zions Bancorporation sold $1.4 billion of senior preferred stock and warrants to the U.S. Treasury as part of the CPP. Since many of the comments I have received center on misperceptions related to the CPP, I’d like to address the facts related to the program.

The Treasury’s CPP was designed to restore confidence in the financial system by strengthening the capital ratios of well-managed banks during this very uncertain economy so that those banks can make loans available to credit-worthy borrowers without being constrained by capital ratios. From its inception, the CPP has been available only to healthy banks.

While Zions did not contribute to the current turbulence in our economy — we never originated or purchased the subprime mortgage loans that are at the root of the crises — we believe we can play a part in helping to resolve the current economic slowdown by making loans available as a result of our infusion of TARP capital.

The term “bailout” has been mistakenly used in connection with discussions on the Treasury’s CPP. As opposed to a bailout, which implies that free money was given to rescue troubled banks, the CPP provides for federal investments in healthy banks. These investments will be repaid, and participating banks will pay dividends to the Treasury until they are repaid. The initial dividend rate is 5 percent per year for the first five years and increases to 9 percent per year thereafter. The Treasury also receives warrants to purchase either common or preferred stock depending on whether the financial institution is a public or privately held organization.

The fact of the matter is that the Treasury is expected to make millions of dollars on its investments under the TARP CPP. The net cash inflow to the Treasury from its investment is estimated to exceed $30 billion. In addition, the warrants issued to the Treasury are conservatively valued at between $10 billion and $15 billion. The total return to the government is likely to be somewhere between $40 billion and $45 billion. So the Treasury’s Capital Purchase Program is a true “win-win” — healthy banks, like Zions, are able to strengthen capital at a time when normal capital markets are closed, taxpayers get a good return on their investment, and the entire economy benefits.

Some have questioned whether banks are lending, and some have even implied that banks that have received capital under the TARP CPP program are sitting on those funds. However, the evidence proves otherwise. Zions has money to lend, and we have been aggressively soliciting loans from credit-worthy consumers and businesses.

While this is a challenging environment for Zions and the industry, we continue to successfully extend new credit and serve our clients. In the fourth quarter of 2008 alone, Zions Bancorporation originated $4.6 billion of credit, including $2.7 billion of new loans. We have money to lend.

For more than 135 years, Zions Bank’s goal has been to create value, and we believe our participation in the Treasury’s CPP reflects our continued efforts to achieve this goal by making credit available to creditworthy individuals and businesses. This, in turn, will help them — you — weather this economic storm and strengthen the economy.

A. Scott Anderson is President and Chief Executive Officer of Zions First National Bank

Featured in the March/April 2009 issue of Zions Bank’s Community magazine.

*Artwork from vinicius.cipriano under Creative Commons license at Flickr.com.

THE WAY I SEE IT |

As the nation’s credit crisis has continued to make headlines, the United States Department of Treasury has continued to develop new tools to engender confidence and strengthen liquidity in the financial system. A major new element of the government’s response is the Capital Purchase Plan, an element of the Emergency Economic Stabilization Act recently passed by Congress, by which up to $250 billion is being invested in healthy banks that form the backbone of our economy. This new capital is being provided in the form of senior preferred stock, with a coupon rate of 5 percent for the first five years, after which the rate increases to 9 percent. Warrants to purchase common stock at current prices, in an amount equal to 15 percent of the total investment, are also provided to the government. The structure of the program virtually ensures that these taxpayer funds will not constitute a “bailout,” but rather an investment that will be fully repaid by the many banks receiving this investment.

Zions Bancorporation has received a $1.4 billion allocation of this capital, providing us with an exceptionally strong capital base during a period that is shaping up to be one of the most challenging in the nation’s economic history. When combined with the nearly $300 million in new capital we raised in the third quarter, these new funds will raise our Tier 1 Capital Ratio to approximately 10.9 percent—more than 80 percent greater than the regulatory “well-capitalized” threshold.

Our participation in the Capital Purchase Plan will ensure that our balance sheet remains very strong relative to our peers, and will enable us to continue to effectively serve our customers. We expect to use the capital to support our ability to provide credit in the communities we serve. Our ability to leverage this capital and further expand our loan production will depend as well on continuing to build our deposit base and prudently underwriting and pricing credit risk. But this is a very important step forward by the government in enabling the banking industry to begin unthawing the frozen plumbing of the nation’s credit markets.

When combined with the increase through the end of 2009 in FDIC deposit insurance coverage to $250,000—with unlimited insurance coverage on noninterest bearing demand deposit accounts—the Capital Purchase Plan provides us with tremendous resources to help serve customers and increase their confidence in our banks, and in the financial system.

Harris H. Simmons is chairman, president and chief executive officer of Zions Bancorporation.

Originally published in November 2008 Zions Bancorporation News Volume 2 issue 9.