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The Bond Market MONSTER : Some Demonize It, But It's a Creature of Our Own Making


"I used to think if there was reincarnation, I wanted to come back as the President, the Pope, or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everybody." -- Presidential adviser James C. Carville, quoted in the book "The Agenda" by Bob Woodward

As the governors of the Federal Reserve Board voted their sixth official interest rate increase of 1994 last Tuesday, picketers from organized labor and consumer groups marched in front of the central bank's fortress-like Washington headquarters.

"Jobs, Not Rate Hikes," one placard read. "Greenspan, Have You Ever Been Out of Work?" asked another.

But even within the ranks of Americans who oppose the Fed's policy of raising interest rates to slow the economy, many believe the protesters' anger is misdirected.

Don't blame the Fed, they say. Blame the bond market--that faceless manic multitrillion-dollar monster that swoons at the mere thought of a healthy economy that could bring an uptick in inflation.

"Monetary policy in this country is controlled by bond traders who live in high-rises and are completely out of touch with reality," argues Jerry Jasinowski, head of the National Assn. of Manufacturers, whose members don't want to see growth in a chokehold.

By Jasinowski's reckoning--and that of more than a few other Fed critics--the central bank has felt compelled to punish the economy with ever-higher short-term interest rates this year mostly to appease a seemingly select group of investors who own bonds.

Bond owners, the logic goes, can't stand the idea of meaningful economic growth because they're terrified of the possibility of higher inflation, which would erode the value of money they've locked up in long-term bonds at fixed rates.

Yet as Jasinowski and others point out, the economy has advanced this year without higher inflation. With 1994 almost over, consumer prices are rising at a lower rate even than in 1993--an annualized 2.6% through October, versus 2.7% last year.

Moreover, many experts argue that with bitterly intense competition in the global economy and labor in excess supply worldwide, inflation simply won't be a problem in the '90s. Someone will always do things cheaper.

The bond market, however, is not impressed. Whereas the Fed controls short-term rates, bond investors determine longer-term rates, which are considered much more important to the economy's health. And all year long the bond market has pushed long-term yields ever higher. The investors' message to the Fed, according to those who would demonize the bond market: "Inflation is coming! Inflation is coming! Keep tightening credit and stop the economy!"

Investors today are demanding an annualized yield of 8.12% to take the risk of owning a 30-year U.S. Treasury bond, a benchmark for long-term rates. Just a year ago, 30-year T-bonds were sold at a yield of 5.8%, the lowest in 20 years.

The surge in bond yields to three-year highs has blasted other long-term interest rates worldwide higher as well this year, boosting the cost of mortgages and car loans and the price at which many businesses and governments borrow. Indirectly, the stock market has been affected as well, with bond traders' counter-intuitive thinking--that good economic news is a bad omen--now holding sway on Wall Street.

But whereas the bond market's critics paint it as a towering, malicious monster, some analysts see an entity more akin to a pitiful, helpless giant--the uncontrollable creation of a decades-long binge of government, corporate and consumer borrowing.

It is powerful, dangerous and often irrational, but "this is not some private club," says James Bianco, a bond historian at Arbor Trading Group in Barrington, Ill. "Think of who the bond market is," he says. "It's pension funds, 401 (k) (retirement) accounts, mutual funds, governments, corporations, individuals. When you add it all up, we're all bond holders."


What's more, higher long-term interest rates appear to have had only a minimal effect so far on the broad economy, which continues to expand and create jobs. But the damage to bond holders themselves has been devastating: Every increase in current bond yields devalues older bonds issued in recent years at lower yields.

By Bianco's calculations, interest rates have risen so rapidly over the past 12 months that bond holders have experienced the most severe devaluation of their securities in this century.

"The greatest number of victims of higher bond yields have been in the bond market itself," agrees Bruce Steinberg, economist at Merrill Lynch & Co.


The image of the bond market as a bogyman is a relatively new one.

In the United States and abroad, bond markets for most of the 20th Century were the staid province of high-quality borrowers, such as sovereign states and major corporations, and highly conservative investor/creditors, such as bank trust departments.

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