The Interest in the Direction of Rates Is Growing

By TOM PETRUNO

Feb. 10, 1992 12 AM PT

Long-term interest rates have bounced up since the beginning of this year, but many experts believe that a peak in rates is near.

The top could be reached sometime this week or next, coinciding with the Treasury’s mammoth bond auction. On Tuesday, Wednesday and Thursday, the Treasury will sell a total of $36 billion in three-year notes, 10-year notes and 30-year bonds.

These sales occur once a quarter, and the effect is often the same. In the weeks before the auction, bond yields in general begin to climb on fears that the Treasury will have to offer sharply higher yields to entice investors to the new bonds.

Once the auction is over, though, the market settles down and rates stabilize or begin to fall.

Since Jan. 1, the yield on 30-year Treasury bonds--the most-watched barometer of long-term interest rates--has jumped from 7.39% to Friday’s close of 7.76%. Though the yield remains below its level of one year ago, the rise has nonetheless stoked fears that rates are beginning a long climb back to the double-digit territory of the mid-1980s.

What’s also scaring some investors is the widening spread between short-term interest rates and long-term rates. That spread now appears to be wider than at any time since World War II:

* Three-month Treasury bills now pay just 3.73%-- four full percentage points less than the 30-year T-bond.

* In contrast, the spread between those yields one year ago was just two percentage points, when three-month T-bills paid 5.95% and 30-year bonds paid 7.98%.

Though such a wide gulf between short- and long-term rates is supposed to persuade more investors to invest longer-term, the recent rise in bond yields shows that many investors remain reluctant to sink their money into bonds.

Suspicious about the dramatic yield spread, many investors apparently are taking the view that interest rates are certain to rise significantly from here.

But many experts believe that such expectations are way off base.

“I think we’re seeing the highs in yields for the first quarter,” said Lacy Hunt, chief economist with HongkongBank Group in New York. “Long rates have to come down from here.”

Friday’s report on January unemployment was a sure sign that “the economy is in serious trouble,” Hunt said. The Labor Department said 8.9 million Americans were jobless in January, the highest number since 1984.

Hunt argues that continued weakness in the economy ensures that overall demand for money is going to stay low. Though the federal government continues to borrow record amounts, business and consumer credit demand has plunged. In fact, 1991 saw a 0.9% decline in consumer credit (car loans, credit cards, etc.), the first year-over-year drop since 1958.

What about the January surges in mortgage financing and corporate bond issuance? Analysts point out that many homeowners and corporations are refinancing old loans at lower rates, not adding on new debt. While such refinancings temporarily push long-term rates higher as borrowers crowd into the market all at once, the pressure doesn’t last long.

“I think the big corporate borrowing needs have already worked through the system,” said Maria Ramirez, economist at Ramirez Capital Consultants in New York. Consequently, she said, “it’s going to be very difficult to sustain long-term rates” at these levels in a slow-growth economy.

Some bond market experts aren’t so certain, though. “The long-term bond market is like the stock market--it anticipates, “ said Bill Corneliuson, a bond portfolio manager at the Strong Funds mutual fund group in Milwaukee. “The bond market is looking ahead one year from now,” he said, and evidently doesn’t like the view.

Corneliuson believes that the bond market sees the economy recovering later this year, and with it demand for money from businesses and individuals who want to make major purchases or investments. Coupled with Uncle Sam’s continued ravenous appetite for credit, rising demand for loans from the private sector is bound to put periodic upward pressure on interest rates, Corneliuson said.

Money, after all, is like any other commodity: The price goes up when demand goes up.

The January jump in long-term rates also is a reflection of bond investors’ concern about ill-conceived “quick fixes” for the economy, Corneliuson said. President Bush’s health care plan is a case in point. “I think the bond market is saying, ‘Hey, what’s with this health insurance thing? How is that going to be financed?’ ” Corneliuson said.

Even so, he doesn’t believe that interest rates will climb substantially from here. At most, he expects the 30-year T-bond yield to rise a half-percentage point by spring, to about 8.25%, then fall back.

And over the next few years, Corneliuson still expects that the long-term trend in interest rates will be down, as the nation shifts much more to a savings mentality, away from the consumption mentality of the 1980s.

If the long-term picture is basically OK, why do bond investors periodically panic, acting as if they’re afraid of their own shadows?

Some Wall Streeters believe that bond investors simply are professional paranoids who always must have something to worry about. But it’s worth noting that such seeming paranoia serves a purpose. It acts as a conscience for stock investors, the Congress, the President and a lot of other folks.

When investors suddenly become afraid of locking their money up in long-term bonds--sending interest rates up--they’re sending a message that something’s wrong with the national outlook. That gets the attention of both Wall Street and Washington, and often helps keep either the stock market or politicians--or both--from making short-term decisions that would ultimately harm the nation’s long-term interests.

Long vs. Short Rates: A Huge Spread The Treasury will sell $36 billion in long-term notes and bonds this week at its quarterly auction, and investors should be lured by the huge premium on those securities over short-term interest rates. But will they?

Rates on Treasury securities now and at previous auctions (in percent)::

February, 1991:

30-year: 7.98

Three-year: 6.98

Three-month: 5.95

May, 1991:

30-year: 8.21

Three-year: 7.09

Three-month: 5.51

August, 1991:

30-year: 8.17

Three-year: 6.92