BUSINESS

Rates Start to Weigh on Investors

The Federal Reserve's job only gets tougher from here. Which explains a lot about the recent turmoil in global financial markets.

The Fed has been raising its benchmark short-term interest rate since June, when the rate was at a generational low of 1%. Everyone knew that was an emergency level for an economy no longer facing an emergency. So a series of six quarter-point rate hikes didn't surprise anyone.

Last week brought No. 7, which put the Fed's rate at 2.75%. That was no shocker either. But the Fed's post-meeting statement did give Wall Street a jolt.

Chairman Alan Greenspan and peers used the statement to issue an inflation warning, the first since 2000. "Pressures on inflation have picked up in recent months," the Fed said. In a five-paragraph statement mostly filled with boilerplate, those nine words obviously were carefully chosen; they were meant to send a message.

But what's the message? The Fed, as usual, wants to leave some things to Wall Street's collective imagination.

The central bank could be saying that it may begin raising rates at a faster pace than quarter-point increments, to slow the economy and brake inflation. Or, to that same end, it could be saying that rates ultimately may go higher than what many people have been expecting.

Or the Fed could be jawboning the financial markets — trying to frighten long-term interest rates up, for example, and to scare currency traders away from pushing the dollar lower. A rise in bond yields could slow the economy, particularly the housing sector. If the dollar's long slide is halted, the upward trend in import prices could end.

Even if Greenspan wanted to tell the nation exactly what he planned to do, he couldn't — because the Fed has no way of knowing how high inflation might go.

Thanks in large part to soaring oil prices, the U.S. consumer price index was up 3% over the last 12 months. That's hardly a disaster. If financial markets started worrying about 4% or 5%, however, the story would become much more troubling. The Fed last week wanted to show that it was vigilant and would do whatever was necessary to damp inflation.

Investors, who generally fear inflation because it erodes the value of financial assets, appreciate the Fed's concern. Then why have markets slumped the last three weeks? It may be sinking in that the easy part of the central bank's credit-tightening campaign is over. The next phase of rate increases is likely to have a much more profound effect on the global economy than the phase that took the Fed's rate from 1% to 2.75%.

If the Fed raises rates too much from here, it runs the risk of global recession. If it doesn't raise rates enough, inflationary forces could get the upper hand.

For central bankers, these risks are the same as always. But after three years of extraordinarily low credit costs worldwide, investors are being reminded that bad things can happen when interest rates, or inflation, or both, are rising.

Hence, stocks have weakened around the globe since early March, leaving most categories of stock mutual funds in the red this year. Bonds too have lost value as long-term interest rates have risen, depressing the prices of older fixed-rate securities.

Investors are repricing stocks and bonds to account for new risks — for example, that tighter credit could cause ugly financial blowups among heavy debtors around the globe. That debtor list includes some governments, companies and individuals.

Many Wall Street pros say markets have been overdue for a risk reassessment. Greenspan himself in February spoke of a "conundrum": Why, he wondered, were investors willing to accept such relatively low yields on long-term bonds at a time when the Fed was pushing short-term rates higher and signaling that there was more to come?

One answer is that there is a huge sum of money sloshing around in this nearly all-capitalist world, and not enough attractive places for it to go.

"Globally, we've got excess capital seeking too few returns," said Eric Hiller, chief interest rate strategist at Bank of America in Chicago.

If that excess capital doesn't disappear soon, it could guarantee that the current pullbacks in financial markets will be short-lived — just "corrections" that allow investors to get in at better prices, before the next run-up.

Real estate investment trust shares have taken a hard hit this year, in part because of fears that higher interest rates will hurt the property market. The average REIT stock mutual fund is down 7.3% since Jan. 1.

REIT shares also fell sharply last spring. That sell-off ran its course in just six weeks before buyers poured back in.

One tip: Investors who like the long-term outlook for emerging-market stocks and bonds might want to hope that the recent selling in those markets continues for a while, to afford an entry point similar to what REIT buyers got a year ago. Mexico's stock market, one of the world's hottest last year, is down 7.4% since March 7.

What about U.S. bonds in a rising rate environment? Bill Gross, the Newport Beach-based bond guru at Pimco mutual funds, said he thought a fair yield on the 10-year Treasury note would be about 5.5%, compared with the 4.59% the notes yielded as of Friday.

But Gross said he was forced to temper his expectations for how high the T-note yield might go because foreign investors, such as the Bank of Japan, have been willing to buy at yields even well below current levels.

For people who are unwilling to take a chance on stocks or bonds as interest rates — and risks — increase, the good news from the Fed's statement last week was that returns on cash accounts, such as T-bills and bank savings certificates, will only get better.

Cash may not be the best place for investors' money in the long run, but those who have it may feel a lot better these days than those who don't.

Rebates on Credit Cards Can Be Tough to Figure

Finding the best deal for you entails reading a lot of fine print. If you keep a balance, interest fees exceed the cash back.

Arthur Krieger makes money when he uses his credit card. The problem is, he doesn't make enough.

Like many Americans, Krieger has a credit card that pays him a reward, or rebate, based on how much he charges.

Krieger said he spent about $9,000 on his co-branded American Express-Costco card last year and got $89 cash back. But that was about $50 short of what he thought he'd been promised.

After several phone calls, Krieger said he learned that the rebate formula he thought was simple was anything but. He had thought he would get a rebate amounting to 1.5% of his charges. But the rebate formula was tiered, paying 0.25% of his first $2,000 in charges, 0.5% on charges between $2,000 and $5,000 and 1.5% on charges above $5,000.

It was Krieger's welcome into the often complicated but potentially lucrative world of cash rebate credit cards.

With cash rebate cards, consumers can get something for nothing — but it's hard to spot the best deals unless you read the fine print. Moreover, charging purchases to get cash back is only a good idea if you can afford to pay off your monthly credit-card balance in full.

If you carry a revolving balance, you'll almost certainly pay more in interest than you will get in cash rewards.

"I'm tired of this telling you one thing and doing another," said Krieger, a Los Angeles resident, who still smarts at the fact that the big-print promises are scaled back in the fine-print details. "This is the second time I've had this kind of problem with American Express."

American Express said it couldn't comment about Krieger's account but noted that its rebate formula was spelled out in cardholder documents.

Rebate cards, which refund 1% to 5% of consumer charges in the form of cash or gift certificates, are the latest hot spot in the credit card market-share battle, said Ken McEldowney, executive director of Consumer Action in San Francisco. The cards are offered by nearly all of the nation's major card issuers.

One reason that the cards have become so prevalent is a shift in consumer attitudes, said David Robertson, publisher of the Nilson Report, a credit card newsletter based in Carpinteria.

In the past, the "must have" reward was airline miles, he said. But consumers now view those with suspicion as airlines place greater restrictions on the use of free miles and people fear that financially struggling airlines may not be around when they are ready to redeem their miles.

"There are a lot of people asking themselves whether they want to turn from their airline card to something new," Robertson said. "Because market share in the credit card industry is dominated by a handful of huge companies, they all have the wherewithal to dangle a shiny card in front of you."

That leaves consumers with plenty of choices.

Consider the Discover Card, one of the nation's oldest cash rebate cards. Its rewards give better returns to those who spend less. Cardholders get 1% cash back on up to $1,500 in annual purchases, but only 0.5% on purchases exceeding that amount.

American Express offers three different cash-back cards, all in cooperation with Costco. The rebates are paid once a year in certificates that can be redeemed at Costco stores for cash or merchandise.

One of those cards — the one Krieger got — reverses the Discover formula, rebating the most to those who spend the most. The company's other two Costco cards have a somewhat simpler rebate formula. On those cards, the rebates amount to 3% of restaurant purchases, 2% on travel charges and 1% on everything else.

There's no tiered formula with those cards, dubbed "TrueEarnings," said American Express spokesman Channing Barringer. The full rebate applies to the first dollar charged.

BankOne offers a cash rebate card that pays the cardholder a penny for every dollar charged up to $60,000 per year. Translation: Maximum annual rebate is $600.

Citibank offers a similar card, but it pays a higher percentage — 5% — on purchases made at gas stations, supermarkets and drug stores, but caps the annual rebates at $300 a year. However, those who sign up for the company's "dividend network" can get unlimited rebates on purchases made from Citibank partners in the program, such as clothing retailer Land's End and Princess Cruises.

"You need a flow chart to figure out which rebate card is best for your use," McEldowney said. "But, as long as you pay off your balance each month and are careful about how you use the card, there's no downside."

The one caution: Some of the cards encourage consumers to carry a balance, he noted. American Express, for instance, pays a "bonus" rebate on some cards to those with revolving balances. But the rebates are never sufficient to compensate for the interest charges, consumer experts agree.

"If you carry a balance, these rewards, whether miles money or gifts, are never worth it," compared with paying down your debt, said Edmund Mierzwinski, consumer program director at the U.S. Public Interest Research Group in Washington, D.C. "If you are a convenience user, make a decision about which rewards you want. But if you are carrying a balance, the interest you pay far outweighs any benefit."