Inflation Fears Pound Bond Prices Lower

Bond prices took another drubbing Monday amid rising fears of bonds’ most dreaded enemy, inflation.

As investors worried that the Persian Gulf crisis would drive up oil prices, the benchmark 30-year Treasury bond slumped 2-19/32 points, or $25.94 per $1,000 face amount, while its yield soared to 8.80% from 8.56% on Friday. Bond yields rise as bond prices fall.

“There are many ways this Kuwait crisis could end, but almost every one involves higher-price oil,” said Kevin Flanagan, economist at Dean Witter Reynolds. “They’re feeling the implications in every corner of the market.”

Also troubling to investors was the prospect of the U.S. Treasury selling another $32.25 billion in bonds this week in its quarterly refunding and the implications of the unemployment statistics released last Friday. The report showed joblessness rising 0.3 percentage points in July.

Some analysts recalled the 1979-80 oil crisis, in which some bond buyers suffered huge losses as the effects of oil price increases pushed inflation higher.

By some measures, the bond market performed worse than the stock market in that period. In 1979, for example, the Dow Jones industrial index lost 11% of its value from the year’s high to its low, while the 30-year Treasury bond was off 12%.

Inflation erodes the value of all bonds, but in particular the bonds with the longest maturities, and analysts said investors have been shunning long-term instruments in the past three sessions while they await a clearer picture of the likely outcome of developments in the Persian Gulf.

At 8.80%, the 30-year T-bond now is the highest since early May.

Volume in trading of long-term bonds was reported to be very light. Analysts said the bond market’s decline also in part reflected disappointment that the Federal Reserve didn’t cut interest rates Monday, as some had expected.

Shorter-term government securities fell 1/8 to 3/4 point, while intermediate maturities were off 5/8 to 1-19/32 points, according to Telerate Inc.

The Treasury’s auction begins today with the sale of 3-year notes. The government will attempt to sell 10-year notes on Wednesday and 30-year bonds on Thursday. A key concern is whether foreign investors will be willing to bid for the bonds, given the uncertainty in global markets.