Bond-market sag has investors - and US officials - anxious
A price drop in government bonds of 15 cents or so per $1,000 bond (1/64th of a point) used to be seen as a sweeping change, says Ralph F. Peters, chairman of Discount Corporation of New York, a major bond dealer.
Not anymore. In recent months there have been ''very substantial swings'' in prices, Mr. Peters says, where the market shifts $20 or $30 per $1,000 bond (2 or 3 points) in a day. As a result ''there is much more risk in holding a position,'' he said.
The upheaval in the government bond market has had a profound effect on dealers and investors in Treasury securities. And because the federal government relies on the government securities market to finance its operations, all citizens are ultimately affected.
In the wake of the collapse of several small government securities dealers, the Federal Reserve Bank of New York has proposed standards for the amount of capital that dealers would have to keep on hand to protect customers. Congress has also shown interest in the subject. But action on new rules is not expected in the near future.
In the meantime, participants in the government securities market are assessing the damage to their portfolios. Before rallying Thursday and Friday, Treasury bond prices had dropped about 17 points, or $170, for each $1,000 since mid-January. That pushed yields to nearly the 14 percent level, the highest they had been since February of 1982.
The Treasury's widely watched 30-year bonds due in 2014 closed last week yielding 13.53 percent as investors cheered signs that the economy may be slowing, thus reducing pressure on inflation and interest rates. Since bonds carry fixed-interest-rate coupons, an increase in market rates causes bond prices to drop, while a decrease in interest rates causes bond prices to rise.
The slide in bond prices is just one sign of turmoil in the government securities market. At the May 11 auction of 30-year Treasury bonds, investors balked at buying the bonds from dealers until the price of the securities was slashed. The dealers buy new government debt from the Treasury and distribute it to investors, thus allowing the government to finance its operations and raise funds to cover the deficit.
Plunging bond prices also pushed one small government securities dealer, Lion Capital Group, into Chapter 11 bankruptcy. And the nation's largest insurance broker, Marsh & McLennan Inc., took a $155 million pretax loss on a $2 billion position in Treasury bonds.
The effect of the price slide on bond dealers and investors has been profound. The total loss in private wealth since January is ''substantially larger'' than $60 billion, according to Jon S. Corzine, the partner in charge of US government securities trading at Goldman, Sachs & Co., the investment house.
With high yields available in the bond market, investors find stocks less appealing. So the bond market decline has partly fueled the stock market's recent slide. But last week bonds rallied and Friday the Dow Jones industrial average posted a 19.5 point gain, its biggest in seven weeks, to close the week at 1,124.35 up 17.25.
One sign of the economy's continued strength was the drop in unemployment in May, to 7.5 percent, from 7.8 percent the previous month. That put unemployment at its lowest point in three years.
More encouraging to investors was news that the government's index of leading economic indicators rose a modest 0.5 percent in April and that factory orders fell 3.6 percent. To some, that showed the economy was slowing, and ''that could help interest rates in the future,'' according to Jerome Hinkle of the Sanford C. Bernstein & Co. bond house.
Despite some signs of the economy's apparent slowing, the turmoil in the government securities market may not be over, since some analysts think interest rates will rise further - and bond prices move in the opposite direction from interest rates.
''As shocking as the dramatic rise in yields over the last two months has been, . . . it only scratches the surface of what will be required to significantly slow economic growth and contain inflation,'' Robert Giordano of Goldman Sachs Economics recently told clients.
''What is wrong is that the market is suffering from a crisis of oversupply of (government) securities'' as the government finances its massive deficit, Goldman, Sachs executive Corzine says. Prices also dropped because tighter Federal Reserve monetary policy pushed up interest rates elsewhere in the economy.
The troubled waters in the government bond market have aroused the interest of Congress and of the Federal Reserve, which supervises the 37 primary government securities dealers. The New York Federal Reserve Bank has proposed a set of capital-adequacy guidelines for the primary dealers, which they in turn would enforce as a standard on those with whom they deal.
''The need for capital guidelines is quite clear, in our view,'' says Edward J. Geng, senior vice-president of the Federal Reserve Bank of New York.
Messrs. Geng, Peters, and Corzine spoke at a hearing on the guidelines the House Banking Committee held in New York last week.
The 37 top dealers in government securities have major reservations about the capital-adequacy guidelines. The dealers are already monitored by the New York Fed. The Fed's first step should be to extend the same oversight and surveillance they are under to ''all non-regulated government security dealers, '' Corzine says.
Among other things, the primary dealers now submit to periodic Fed review, file certified external audits, adhere to internal Fed capital-adequacy requirements, and file daily reports on all trading positions and activity.
The primary dealers contend that the capital-adequacy regulations would limit dealers' legitimate flexibility to meet changing market conditions and could push up the cost of financing the government.
Geng said legislation might be needed if the dealers did not agree to the capital plan.