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What's Bothering the Bond Market?

February 05, 1996|TOM PETRUNO

The Federal Reserve Board and the stock market agree that the economy needs lower short-term interest rates to avoid recession. The bond market seems to think otherwise.

Longer-term bond yields jumped late last week, either mocking or disapproving of the Fed's latest cut in short rates last Wednesday. The bellwether 30-year Treasury bond yield ended the week at 6.16%, up from 6.03% on Wednesday and the highest since Jan. 10.

It didn't help bonds that gold--the traditional inflation barometer--surged again last week.

Most Wall Streeters insist that bonds are being buffeted purely by technical issues. For one, the Treasury will auction $44.5 billion in securities this week, a heavy supply for the market to absorb. Also, Japanese bond yields are creeping up from their historic lows as Japan's economy revives, which is encouraging some Japanese investors to sell U.S. bonds and buy their own securities.

But most economists say there is no danger of a fast resurgence in either the U.S. or European economies, or inflation. Even without a balanced-budget plan from Washington, many investment pros think the trend in U.S. interest rates remains down. "I still think the [30-year T-bond] yield can go to 5.5% by summer," says Song Won Sohn, economist at Norwest Corp. in Minneapolis.

Yet even the biggest optimists concede that a continuing decline in short-term interest rates in the United States and Europe, courtesy of central banks, should eventually provoke the desired effect: faster economic growth. If the world economy is currently healthier than central banks believe, growth could revive much more quickly--and potentially bring higher inflation. If bond investors can't shake this fear soon, bonds' sell-off could get much worse--with unpleasant implications for the stock market.

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