CREDIT : Discount Rate Hike Hurts Bond Prices : Key 30-Year Issue Zigzags to a Nearly 1-Point Drop

An unexpected increase in the Federal Reserve’s discount rate sent bond prices sharply lower Tuesday in active trading.

The Treasury’s closely watched 30-year bond dropped nearly 1 point, or $10 for every $1,000 in face value. Its yield, which moves inversely to its price and is often an indicator of interest rate trends, climbed to 9.19% from 9.10% late Monday.

Bond prices, which had been higher before the Fed’s announcement, zigzagged erratically following the half-point rise in the interest rate charged on the Fed’s loans to member U.S. financial institutions.

The key 30-year issue, which had been up about 1/8 point before the move, lost about 5/16 point afterward and then rallied before declining anew.

Fed Chairman Alan Greenspan “has got the market confused,” said Jay Goldinger, a principal of Capital Insight Inc., an investment firm in Beverly Hills.

Dramatic Move

Many bond traders are fearful that Tuesday’s move could be the first of a series of hikes in the discount rate, he said.

The Fed said it raised the discount rate “to reduce inflationary pressures (and) . . . in light of the growing spread of market interest rates over the discount rate.”

Credit markets are concerned that increased inflation could erode the value of fixed-income securities such as bonds. A rise in interest rates, however, tends to send bond prices lower.

The boost in the discount rate to 6.5% from 6%, which was the first hike in the key interest rate since the stock market crash last October, was the most dramatic move the Fed could take to rein in inflation. Analysts had expected the Fed to tighten its reins on the money supply this week, but few were expecting an increase in the discount rate.

As a result of the Fed’s action, major banks could decide to raise their prime lending rate another half percentage point, noted Elizabeth Reiners, a vice president of Dean Witter Reynolds Inc. The prime, a benchmark rate against which banks set rates on a variety of business and consumer loans, was increased to 9.5% from 9% about a month ago.

Fed Funds Rate Steady

However, some analysts said they didn’t expect much change in short-term rates, such as the federal funds rate, which is the interest on overnight loans between banks.

Yields on three-month Treasury bills, meanwhile, jumped to 7.27% as the discount rose 12 basis points to 7.05%. Yields on six-month bills advanced to 7.78% as the discount soared 15 basis points to 7.40%. Yields on one-year bills rose to 8.13% as the discount surged 11 basis points to 7.57%.

A basis point is one-hundredth of a percentage point. The yield is the annualized return on an investment in a Treasury bill. The discount is the percentage that bills are selling below the face value, which is paid at maturity.

The fed funds rate was quoted late in the day at 7.688%, unchanged from late Monday.

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