Interest Rate Scenarios Murky

Insurers pondering 2007 investments must deal with a murky interest situation, according to Robert Hartwig, president of the Insurance Information Institute.

Mr. Hartwig's comments came as A.M. Best Co. in Oldwick, N.J., said in a report that despite the best intentions of the Federal Reserve this year, interest rates may still rise.

According to Best, even with weakening business activity, inflation and dollar difficulties have the potential both to frustrate the Fed's effort to suppress interest rates and to push long-term interest rates higher.

“This is particularly true given the inversion of the yield curve from heavy, non-U.S. buying of U.S. Treasury securities,” the report said.

Since the Federal Reserve began tightening in mid-2004, the short-term rates have moved higher by about 400 basis points, but the 10-year yield is little changed, up about 30 basis points for the same period, leading to a negatively sloped yield curve (short-term yields higher than long-term), Best reported.

Mr. Hartwig said investment officers have the choice of locking in long-term rates now lest they fall further, or sticking with short-term instruments because of the higher yield.

According to Best, instead of recession fears or lack of inflation containing long-term yields, yields have been suppressed by strong demand for Treasuries from outside the United States.

Mr. Hartwig said the so-called inverted curve creates a situation that is “somewhat murky for insurers.”

“The decision to go long is fraught with interest rate risk. It is easy to envision situations, such as an oil-induced inflation shock or war, which could drive interest rates up sharply in the years ahead,” he said.

The Best report said the ever-burgeoning U.S. trade deficit has sent a continual stream of excess U.S. dollars into global commerce. Much of that, the rating firm said, has been returned to the United States through “rest of world” buying of U.S. Treasury instruments.