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It's Alive (Again)! The Bond Monster Awakes in a Rage

May 16, 1999|Tom Petruno

A long time ago in a galaxy far, far away, there was no monster more evil or more feared than the bond market.

Guess who's back?

A shockingly high April consumer inflation report on Friday caused the biggest one-day jump in long-term bond yields in nearly three years. Every bond trader who has spent half a lifetime looking for inflation finally found some--and responded as expected: Sell!

Naturally, the highest bond yields in 12 months didn't go over well with the stock market, either. The Dow Jones industrials slid 193.87 points, or 1.8%, to 10,913.32, and the main Nasdaq stock index dropped 2.1%.

But given how negative Wall Street suddenly has turned with regard to interest rates and inflation, things could have been a lot worse Friday in the equity market.

Perhaps one reason stocks didn't decline even more is that it has been a long time since investors have had to contend with a significant jump in market interest rates tied to inflation fears. Many people may not be quite sure how they're supposed to act.

The bond market hasn't had a major inflation-fueled conniption since early 1996, when the yield on the benchmark 30-year Treasury bond surged from 6% to 7.1% in the course of about four months.

Except for that period, long-term Treasury yields have been sliding, with few interruptions, since late 1994. Any wonder the Dow has soared from 3,800 to 11,000 since then?

Now, with Friday's jump from 5.75% to 5.91% on the 30-year T-bond, we're up more than a full percentage point from last fall's lows--when fears of deflation, rather than inflation, were gripping global markets.

If rising Treasury bond yields occurred in a vacuum, most Americans would surely be content to ignore bond traders' manic mood swings.

But if those traders are demanding higher yields to compensate for what they believe will be rising inflation, other market interest rates will rise in tandem.

Fixed-rate, 30-year mortgages were already at two-month highs by last Thursday (an average of 7.1%), even before Friday's surge in bond yields. So home buyers will be paying even more soon.

(Home builders' stocks were among the biggest losers on Friday: Kaufman & Broad's shares dropped 4.5% for the day.)

Companies that borrow via high-yield junk bonds also are paying more to finance themselves: The yield on the KDP index of junk bond issues surged to 9.48% on Friday. It was 9.22% a week earlier, and 9.11% in late April.

There is, of course, some good news underlying all of this: Those global deflation/depression fears of last year have all but vanished.

Stock markets worldwide have zoomed this year, suggesting renewed optimism about the global economic outlook.

Last week, the Brazilian government stunned investors by announcing that that economy actually grew 1% in the first quarter from the fourth quarter, despite enduring a (seemingly) devastating currency devaluation in mid-January.

Also last week Treasury Secretary Robert Rubin announced his long-rumored resignation. More than a few Wall Street strategists viewed Rubin's timing as a sign that he believes the world is looking at sustained growth ahead and won't need his crisis-management talents any longer.

A skeptic might say Rubin just wants to go out a winner, with the Dow near 11,000 and the adjective "spectacular" still appearing in nearly every sentence describing the U.S. economy's performance.

"How much better could it get?" asked Ned Riley, investment chief at BankBoston Corp.

Indeed, the dirty work now falls to the Federal Reserve Board, whose policymakers hold a regularly scheduled meeting on Tuesday--where the April inflation report is sure to be Exhibit A.

How bad was that report? Consumer prices overall jumped 0.7% for the month, the biggest monthly rise since October, 1990.

About half of the gain was attributed to gasoline prices, which have rebounded with oil prices as major exporters have cut production to deal with what had been the lowest prices since 1986.

But even the so-called core rate of inflation, which excludes food and energy prices, was up much more than expected--a 0.4% rise. Americans paid more for clothing, airline tickets and housing in April, among other things.

Could it be that American businesses suddenly feel as if they have enormous pricing power? Almost no one believes that.

John Williams, economist at Bankers Trust in New York, called the April report "payback for the ludicrously tame [inflation] readings seen earlier this year. All of the little things that had worked to hold down the core rate in the first quarter suddenly went the other way" in April.

Stephen Slifer, economist at Lehman Bros., notes that "none of the leading indicators of inflation" have suggested in recent months that there is a swelling of inflationary pressures in the economy.

In particular, wage growth has remained tame, and productivity gains have been robust.

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