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Fuss: We're in the Foothills of a Long Rise in Rates

But the upward trend in interest rates may be forestalled as the dollar remains a safe haven for fearful global investors, says the Loomis Sayles Bond manager.

Jacobson: Well, let me just shift gears for one more question. Especially given what you've described--we've talked about some of the risks globally--what are you thinking at this point about inflation and interest rates here in United States?

Fuss: OK--best guess, and all I can do is guess. But I suspect that we are in the foothills of a long rise in interest rates, followed by, not led by, followed by inflationary pressures, some of which will get ahead of interest rates--unit cost to labor, for example--and that's the strongest one, but it doesn't show up in the CPI. But the foothills are rolling like this. I don't think we'll actually be into an upward trend really out of the foothills until our own central bank backs away from buying Treasuries.

Now, the danger in that--you may say, well, in that case, why not just keep this going. I mean the Fed doesn't have to run out of money. They can literally create it... Otherwise, you'd say, well they are about to run out of powder if they could do this as they said they are going to for another six months--they are going to use up everything. Well, that's OK. They can build up their assets again. They don't have to sell something out.

Well, you say, well why not do that forever? I mean the dollar is not weakening relative to other things--lately it's been quite strong, that's true. It has. Why? Good question.

Fear is part of it, and slowdown elsewhere is part of it. Don't discount fear, Eric. I'm giving away my age. I am sounding like an old man. But it's got my attention. There is a little bit, in economic terms, a Guns of August thing rolling here. People are aware of it. You read the first page of the newspaper, you get a pretty good overview. And you say, all other things being equal, if I am somewhere in Asia or if I am somewhere in Europe, or certainly if I am in the Middle East, I think I'll feel more comfortable--and particularly if I am in the Middle East or particularly if I'm bordering the South China Sea--I'll feel more comfortable if I've got my money at least currency-wise and obligation-wise someplace that doesn't have this geopolitical worry. To heck with which way things are going longer-term.

And that's relatively new, that's been building off and on over the last year. So it's not just risk-on, risk-off. There is a permanent risk-off underlying this, and if you trace fund flows, you say, hmm ... just a year or year and a quarter ago, people in China in particular were saying, we are going to diversify our reserves by trade patterns. Oh my god, if there was anything left in New Zealand, let's run and buy it. They are going to put everything in New Zealand. They still would if there was anything left. But other people in the area were saying, yes, we are going to do that, too. But then as this uncertainty built, they said, Oh, wait a minute. Hmm. OK. I think I would rather have my assets in North America.

Canada clearly benefits from this, probably more than we do, or it feels it more--they're not as big. And the U.S. benefits.

Now that is a factor that has not been in the markets since the end of the Cold War, and it's creeping in. If it weren't for that, I think our rates would be a bit higher right now. China is a direct bidder at the Treasury auctions. We've all suspected that, and the Treasury finally said, yes, that's the case. It makes sense; they are the biggest buyer, why not have them be a direct bidder.

So I wouldn’t discount that, and I don't mean to use all your time on this, but this is a real factor. And I don't read that in the papers in the morning, but I feel it, and I watch the flows in our international funds, and I can see where the money is coming from. Geographically, I can see where it's coming from, and I say, there's a pattern here. And so I've, actually, in my travels and when people come to the U.S., I ask them about it, and they say well, oh yeah. In the extreme cases, families are here. Now, that's relatively new.

But on the brighter side, there is real hope for the Red Sox this year.

Jacobson: Well, I think we'll tie it up with that. Thank you so much for joining us today, Dan.

Fuss: Okay. Thanks, Eric. It was fun.

Eric Jacobson does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.