Despite Federal Reserve Board claims that It will keep U.S. interest rates low for a long time, it may not be able to says BMO Nesbitt Burns chief economist Sherry Cooper.

“Bond investors beware. Federal Reserve Bank Presidents and Governors have been falling all over themselves lately trying to assure us that it would be a very long time before the Fed would raise interest rates once again. This makes me very nervous at a time when gold prices are hitting 7-year highs, metals prices are surging, and oil prices keep testing $32 a barrel,” she says.

“Call me a contrarian, but pipeline inflation is on an uptrend in the United States as the global economy rebounds. If the Fed really were to leave the fed funds rate at a mere 1% throughout 2004 — Its lowest level in more than four decades — we could well be poised for a global reflationary cycle and much higher bond yields,” she warns. Cooper doesn’t think this will happen, she expects that the Fed would give in and raise rates in the second half of next year.

But she does see the global recovery happening, saying that around the world, “evidence of a synchronized global recovery is mounting. Job growth is picking up virtually everywhere. Businesses are investing in computers and software as the painful restructuring of the post-bubble years finally begins to pay off. In the U.S., corporate profits are rising rapidly, approaching a 20% annual gain for S&P 500 earnings this year. At the same time, the U.S. dollar continues to fall, increasing domestic import prices, especially from Europe, Australia and Canada where the currency strength has been most evident.” The long bull market in bonds is over, Cooper declares.

However, she admits that the situation is quite different here in Canada, with overnight rates still at 2.75% and the currency rising. “Clearly the Bank of Canada is still pondering the need for further rate cuts, and would certainly lag the Fed in any rate hikes next year,” she says.

“The big surprise for 2004 could well be a stronger global scene than currently predicted. It is, after all, an election year with the White House, Republican-led Congress, Treasury and Fed having joined forces to reboot U.S. economic growth. With follow through in the rest of the world, and continued self-sustaining strength in China, excess capacity in the U.S. could well fall faster than most people expect, closing the output gap and raising the spectre of higher inflation,” Cooper concludes. “The U.S. bond market would be very sensitive to these developments, driving interest rates upward in coming months. Look for a 5-handle on the U.S. 10-year bond yield, currently at 4.1%, before too long. Mortgage rates, similarly, would rise, and even more capital would flow into the stock market which will continue to outpace bonds.”