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Yields Fall to Seven-Year Low : Bond Prices Surge as Market Buoyed by Drop in Oil Prices

March 03, 1986|DENISE GELLENE | Times Staff Writer

Bond prices surged last week and yields dropped to their lowest levels in seven years, thanks to investor confidence that inflation had finally been licked.

The bond market was buoyed by the sharp drop in oil prices, which is expected to dampen inflation. This optimism drove up the price of the bellwether 30-year Treasury bond by 5 points, or $50 for each $1,000, over the previous week. The higher price sent the 30-year U.S. Treasury bond yield to 8.28% on Friday, a decline from 8.69% for the week.

The euphoria brought in eager investors, who--despite the high prices--rushed into the market to buy before yields dropped any lower. Analysts said the buying was led by foreign investors. The Japanese were especially active, since interest rates are low in Japan relative to the U.S.

"It was a feeding frenzy," said William V. Sullivan, a senior vice president at Dean Witter, the New York investment house. He said eager investors were snapping up bonds "without close attention to value."

Analysts said the rally, if sustained, would usher a return to the era of single-digit interest rates.

However, signs of skittishness on the part of investors surfaced Friday, as the prices of intermediate Treasury issues dipped slightly. Long-term issues finished 7/32 of a point higher on the day. Analysts were unsure how long the rally would last. "That's the $64-million question," said one.

New corporate debt sold last week reached a record-breaking $9.5 billion, as treasurers rushed to take advantage of the lowest long-term rates since 1979. "There's more backed up waiting to go," said James A. Stern, managing director at Shearson Lehman in New York.

Southern California Edison jumped into the market on Wednesday, and sold $300 million in 9 3/4% mortgage bonds--its largest long-term debt issue ever. Howard P. Allen, Edison chairman and chief executive, said the utility had planned to issue only $200 million on March 6. Edison moved quickly, he said, "to obtain an extremely low rate on the issue--our lowest since 1977."

The drop in long-term rates prompted many corporations to replace short-term debt with long-term debt, creating "stronger balance sheets," said Samuel Gordon, a vice president with Moody's Investors Service, a rating agency.

Chevron sold $300 million in 8 3/4% 10-year notes to replace some of its commercial paper, which is unsecured short-term debt. Tom Lister, Chevron assistant treasurer for corporate finance, said that short-term debt incurs "a lot more interest rate volatility risk," which can be avoided with long-term debt, which allows the company to lock in a favorable interest rate for a longer period. Although short-term rates are normally much lower, the sharp decline in long-term rates allowed Chevron to issue the notes at rates very close to what it was paying on commercial paper.

"I guess you could say we saw a window of opportunity," said Lister.

Investment bankers said they expected large amounts of corporate debt to continue flowing into the market. "What we've seen is that there's a lot of pent-up demand to borrow at rates below 10%," said Michael K. Dahood, a Smith Barney executive.

The drop in long-term rates, if sustained, is expected to spill over into the home mortgage market. Fixed rate home loans remain above 10%. Adjustable rate mortgages are being offered at below 10%, but the home buyer must risk higher interest rates in the future.

"We could soon be back to single-digit fixed mortgage rates," said Dennis Jacobe, senior analyst at United States League of Savings Institutions.

Thomas I. Megan Jr., a senior financial economist with Evans Economics, a New York consulting firm, said many homeowners would probably refinance at lower rates, giving them "15 to 20 billion in extra spending money." Megan said this would boost consumer spending and stimulate economic growth.

Last week's rally was bad news for small investors looking for high yields. Dean Graves, a vice president with DeMarche Associates, a Kansas City investment counselor, cautioned investors not to expect the 30% returns they had seen in the debt or equity markets over the past year. He said the average return would likely be in the 10% range.

Investment analysts said the rally was fueled by the expectation that the decline in energy prices would keep inflation low. "Energy has greased the skids of the bond market rally," said Sullivan of Dean Witter.

Oil prices now hover under $17 a barrel, down from a high of $28 last December. "When one major commodity adjusts, all the markets have to adjust," said Fred Henning, a senior vice president at Fidelity, a Boston mutual fund. The swift adjustment has aroused some nervousness, said Henning. "Nothing comes down this far, this fast without some adjustment," he said.

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