Owners of long-term bonds are supposed to have correspondingly long memories. That can be helpful in maintaining a realistic view of the risks inherent in fixed-income securities.
Those long memories may have kicked in last week, after the Bush administration announced its new estimates for the federal budget deficit this year and next.
The deficit for the current fiscal year now is expected to be $455 billion, up from the White House's previous estimate of about $304 billion. For fiscal 2004, which begins Oct. 1, the new deficit estimate is $475 billion, up from $307 billion.
In nominal dollar terms, the nation never has recorded red ink on this scale. The previous record was the $290-billion deficit of fiscal 1992, the final year of George H.W. Bush's presidency.
The deficit revisions were announced Tuesday, the same day Federal Reserve Chairman Alan Greenspan was giving Congress his updated forecast for the economy. For the bond market, Greenspan and the White House amounted to a one-two punch: The Fed chief sounded relatively optimistic about the outlook -- which could mean that interest rates have bottomed -- while the deficit data ensured a massive supply of new bonds coming down the pike.
The result was a sell-off in bonds and a surge in yields. By week's end, the yield on the 10-year Treasury note, a benchmark for other long-term interest rates, was at 4%, up from 3.63% a week earlier and the highest since April 14.
Exactly what makes bond yields do what they do on any given day always is subject to conjecture. But suffice to say, many bond owners are substantially more worried about their investments today than they were, say, in early June.
If market rates on new Treasury bonds keep going up, existing fixed-rate Treasuries will be devalued. That's a certainty.
Some bond investors last week may have been remembering the last times the subject of a ballooning deficit was a hot topic on Wall Street. In the mid-1980s and again in the early 1990s the deficit was soaring, and a primary focus of economists and investors was the potential for unrestrained federal borrowing to "crowd out" other borrowers and drive interest rates sky high.
It was a reasonable concern -- but it proved false.
As the deficit stayed in the then-record $200-billion-a-year range from 1984 through 1986, the 10-year T-note yield plunged from nearly 14% to 7.2%.
