U.S. investors and consumers, hoping for lower interest rates ahead, once again find themselves at the mercy of the Japanese.
The Treasury will auction a total of $30 billion in notes and bonds this week in the federal government's quarterly financing binge. And as usual, the debate on Wall Street has focused on whether the Japanese will buy their traditional 25% to 35% of the securities--and what yields they'll demand.
The auction comes at a critical juncture for the bond market and for interest rates generally. Long-term rates here and overseas jumped in January, taking many investors by surprise. The closely watched 30-year Treasury bond yield closed at 8.50% Friday, up more than a half-percentage point from 7.97% at year-end 1989.
That has pushed other long-term rates higher--such as mortgage rates--raising fears that the housing market will slump further. The rate surge has also pummeled the stock market.
"It's a scary time," admits David Hale, economist at Kemper Financial Services in Chicago. And against that backdrop, the Federal Reserve's policy-making arm meets Tuesday and Wednesday to review its credit stance--and to decide whether the economy is weak enough to warrant pushing short-term interest rates lower. Those rates have remained relatively stable over the past month.
Hale and many other experts believe that the January surge in long-term rates was an overreaction to inflation jitters and overseas rate hikes and that rates soon will ease again. The yields that investors will demand on Treasury notes and bonds to be sold Tuesday, Wednesday and Thursday--$10 billion each in 3-year, 10-year and 30-year securities, respectively--shouldn't be much higher than current levels, many experts say. If so, that should lend more credence to the idea that rates have peaked for now.
What the optimists are betting on: first, that Japanese investors are likely to buy their usual share of the Treasury securities, even though the spread between U.S. and Japanese interest rates has narrowed over the past month.
Ten-year Japanese government bonds now yield 6.4%, compared to about 8.5% on 10-year U.S. Treasury notes. While 2 percentage points might seem like a handsome premium for Japanese investors, it has been far greater in recent years--a necessary bonus to compensate foreign buyers for currency fluctuation risk.
Given the smaller premium, "For foreign investors, you can't say the U.S. market looks attractive now," said Robert Brusca, economist at Nikko Securities International in New York.
Nonetheless, Wall Street believes that Japanese investors will find the Treasury securities attractive enough, especially in light of the dollar's relative stability versus the yen so far this year. A survey of Japanese institutional investors by Japan's Nihon Keizai Shimbun news organization last week revealed a healthy level of interest in the Treasury auction.
Beyond the Japanese buyers, some Wall Streeters are betting that U.S. institutional investors will be active bidders at the auction. "I think dealers have already brought interest rates up to where institutions here will buy," said David Capurro, portfolio manager at the $11-billion (assets) Franklin U.S. Government Securities mutual fund in San Mateo, Calif.
"The buying will be by investors who have a choice between stocks and bonds," Capurro said. Considering the stock market's iffy outlook as corporate profits weaken, an 8.5% annual bond yield ought to look very alluring, he said.
Even if the auction goes well, however, a sustained drop in U.S. interest rates from this point depends on other factors--in particular, whether overseas rates ease. Japanese and West German rates have risen partly on expectations of new economic booms there.
Likewise, there is a growing fear that the opening of Eastern Europe to Western investment will attract much Japanese money that would have flowed here. To keep the Japanese buying U.S. bonds, rates here may have to remain high.
Finally, inflation worries aren't likely to subside soon. The producer price report for January, due out Friday, will probably show a surge in prices because of the December cold snap's effect on food and energy prices, economists say.
While those figures may keep the Federal Reserve from easing credit at its meeting next week, many economists believe that the underlying weakness in the U.S. economy will assure a drop in rates by spring. "When you look at the fundamentals--which is what the Fed will look at--we will see lower rates," predicted Kathleen Cooper, chief economist at Security Pacific Corp. in Los Angeles.