Bond-market slide hints new interest-rate rise
The stock market maybe roaring, but the bond market has been getting clobbered. This important barometer of future interest-rate trends has dropped so dramatically, and long-term yields have risen so quickly, that most brokers report that a kind of numbness has set in.
"I don't remember when it's been this bad," says William Gibson of Smith Barney, Harris Upham & Co.
As an indication of how bad the bond market has been, he points to the US Treasury's long-term 10 3/8-percent notes due in the year 2009. From a price of 102 on Dec. 31, the notes then yielding 10.35 percent have slipped to 92, yielding 11.18 percent. For the bond market this is a major price drop.
As a result of the market's crack, bond analysts are beginning to have second thoughts about whether interest rates actually peaked in October and November."We are all getting more and more bearish by the moment," Mr. Gibson says.
(The slide has even eroded some confidence in the stock market. After managing gains for two successive weeks despite the decline in bonds, the market on Monday, Feb. 4, ran into some heavy selling and fell 6.38 points.)
Analysts cite a host of reasons for the bond slide. Salomon Brothers, in its latest bond market roundup, blames "concern over inflation and government expenditures." There have also been large government financings and a major corporate bond calendar. This week, for example, the government hopes to raise some $7.4 billion, of which $2.6 billion is new cash, not just older issues coming up for redemption. Lawrence Kudlow, chief economist for Bear, Stearns, a brokerage house, calls this refinancing pressure "a major source" of the downward pressure on bond prices.
Also hanging over the market is the knowledge that Ma Bell hopes to raise between $4 billion to $5 billion in new cash this year. Thus, many buyers of this top-ranked debt are holding back -- keeping "their powder dry," as one bond trader calls it.
The state of the economy has also been an element of uncertainty for the markets. After moving down in October and November, the index of leading economic indicators, for instance, rose in December. (This index is a statistical series designed to show whether the economy is heading toward slower or faster growth.) There is still substantial concern that the economy is continuing to overheat. Morgan Guaranty Trust Company, in its most recent survey, concludes: "The economy's continued advance at year-end raises the distinct possibility that overall growth will be sustained in coming months." If such economic activity were to continue, it would be bad for the bond markets, since borrowing demands would remain strong.
By far the biggest concern, however, is that the government will substantially increase defense spending without any subsequent increase in taxes to pay for it or any decrease in nonmilitary spending to offset it. "There are fears that the budget expansions of the 1980s will dominate the money supply," Mr. Kudlow says. Morgan Guaranty adds that "there is always the risk . . . that the nation's resources will be stretched thin, with adverse consequences for the long-run inflationary trend."
Wall Street is also concerned that the government is not reporting its true spending in its proposed budgets. Henry Kaufman, a partner at Salomon Brothers, notes in his firm's Comments on Credit that, despite a projected decline in the federal budget deficit from $40 billion to $16 billion in 1981, borrowing needs will fall only $11 billion. "This is because of a sharp increase in off-budget spending, primarily the needs of the Federal Financing Bank, an institution that finances a variety of credit agencies and obtains its funds directly from the Treasury," he concludes.
Furthermore, Mr. Kaufman maintains that the 1981 budget contains some "soft assumptions," including optimistic economic projections. The budget also does not include the impact of any decrease in taxes, such as the proposed repeal of the already mandated $11 billion increase in social security taxes. As a result , he concludes, US borrowing is likely to be "considerably higher than the official estimate of $33 billion."
Normally, economists would be concerned over the impact on the economy of high long-term interest rates. Mr. Kaufman notes, however, that at present "there is no immediate threat to the economy from high long-term rates; the extraordinary volume of short-term business credit currently being transacted, in fact, suggests the opposite danger." With short-term interest rates running lower than long-term rates, borrowers are faced with little choice.
In the meantime, the long-term bond markets are suffering. "Until the yields pull the buyers out of the woodwork," says Mr. Gibson, "we'll have to sit by and watch the massacre."