YOU ARE HERE: LAT HomeCollections

Inflation Blip Clips Bond Market; Dow Drops 29 : Investors Fret Over Inflation Numbers and Political Turmoil in Russia


A disturbing rise in inflation and renewed political turmoil in Russia sent interest rates soaring Friday, causing a broad, though shallow, decline in stocks.

The bond market bore the worst of Friday's selling, after enjoying weeks of declining interest rates as investors cheered President Clinton's proposals to slash the federal budget deficit.

Yields surged after the government reported that wholesale inflation rose 0.4% in February, the biggest gain in more than two years. By the close of trading, the yield on the benchmark 30-year Treasury bond was at 6.86%, up sharply from 6.76% on Thursday and the highest since March 1.

"We've run out of gas in the bond rally," said Robert DiClemente, economist at Salomon Bros. in New York.

In the stock market, the Dow Jones industrial average finished with a loss of 29.18 points to 3,427.82. But the Dow had been off as much as 50 points at midday, and muted trading volume suggested most investors were nonplussed by the sudden turn in interest rates.

Many analysts had been warning for several weeks that investor euphoria in the bond market had pushed rates too low, too quickly. The 30-year T-bond yield plunged from 7.39% at the start of the year to a 20-year low of 6.66% last Monday.

Since late February, however, the bond market had been ignoring warning signs of higher inflation, as prices of oil, lumber, grain and meat rose markedly. Because inflation erodes the fixed-rate returns on bonds, any hint of rising prices usually causes investors to demand higher yields on bonds to compensate.

Most economists viewed the February wholesale inflation report as a seasonal aberration rather than the start of a significant rise in prices. Nonetheless, they said the report is likely to halt the downward trend in interest rates unless and until new signs emerge that the economy is slowing again.

"The (inflation report) has to be dealt with," said William Dodge, investment strategist at Dean Witter Reynolds in New York. "You're starting to wear the bond market down psychologically."

The turnaround in bond yields could also mean that rates on mortgages and other loans will stop falling and may even begin to back up slightly. Indeed, the Federal Home Loan Mortgage Corp. said Friday that the week's average rate on 30-year fixed-rate mortgages was 7.47%, up from 7.44% last week--the first rise in 10 weeks.

Some analysts said inflation concerns were heightened by news from Russia, where the government is in a state of crisis. Because Russia is a major supplier of industrial commodities such as gold and platinum, a further deterioration of that economy raises the potential for a cutoff in supplies of key commodities.

But Russia's turmoil also helped one part of the bond market: Yields on short-term Treasury bills rose only moderately because demand for those securities was strong. Typically, world crises send investors into T-bills as a safe haven.

The yield on six-month T-bills inched up just 0.02 points to 3.18%, leaving it flat with a week ago.

Meanwhile, the stock market escaped with relatively modest damage Friday. The Dow's 29-point loss amounted to less than 1%. And the NASDAQ market of smaller stocks slipped just 1.50 points, or 0.2%, to 692.78.

While losers swamped winners by a 14 to 5 ratio on the New York Stock Exchange, volume was just 244.7 million shares, subdued by recent standards.

Analysts noted that while higher inflation is automatically bad for bond owners, rising prices could be a sign that business is improving for many companies. Historically, as the economy recovers after a recession, stock investors begin to pay more attention to the potential for higher corporate earnings than to changes in interest rates.

"We believe that we'll eventually have an earnings-driven market," said Gregory Nie, technical analyst at Kemper Securities in Chicago. But he added that stocks could be vulnerable to further profit taking soon, given the heavy recent buying that pushed the Dow and other key indexes to all-time highs this last week.

Longer-term, the bond market's troubles could siphon money out of that market and into stocks.

Among the market highlights:

* The heaviest profit taking was in industrial stocks that had surged earlier in the week. Among the Dow stocks, Alcoa fell 1 3/8 to 69 1/2, Bethlehem Steel dropped 1 to 18, General Electric lost 1 to 86 1/2, Goodyear slid 1 1/8 to 74 1/4, and Caterpillar eased 7/8 to 57 3/4.

* Food stocks also tumbled. They could be hurt if grain and meat prices keep rising. Campbell Soup lost 1 3/8 to 43 3/4, Hershey fell 1 1/8 to 52 7/8, Kellogg dropped 1 to 66 1/4, and Pepsico gave up 1 3/8 to 40 5/8.

* Bank stocks were off only marginally despite higher interest rates, but home builders tumbled. Centex fell 1 1/8 to 32 1/4, Kaufman & Broad sank 7/8 to 19, and Castle & Cooke eased 5/8 to 14.

Los Angeles Times Articles