Bond Market Packs a Punch Clinton Is Already Feeling : Policy: Foreign influence will grow as investors help finance U.S. debt, impacting nation’s interest rates.
As the Administration of President-elect Bill Clinton takes shape and prepares to assume power, key economic policy-makers are beginning to come to grips with the fact that they are not the only ones who will be calling the economic policy shots.
The U.S. government’s huge debt--nearly $4 trillion--and the resulting clout of bond investors here and abroad means that the seat of economic power, once firmly rooted in Washington, will to a greater degree than ever also reside in New York, London, Frankfurt and Tokyo.
Power will not be held only by the Treasury, the Federal Reserve and Congress. Thousands of bond owners and portfolio managers around the world also will have a collective influence--some economists even say veto power--over the Clinton Administration’s policy choices.
“There will be serious constraints on the policy options of the President of the United States in 1993--and it doesn’t matter what his name is,” said Richard B. Hoey, a bond portfolio manager and the chief economist for the Dreyfus Corp., a purveyor of mutual funds.
The government depends on the bond market to finance its ever-growing debt by selling Treasury bonds. It also is constantly rolling over old debt as existing bond issues mature. These arcane transactions play a key role in setting the nation’s interest rates.
If enough bond market participants refused to buy new bonds because they feared that inflation was about to be reignited, rates would shoot upward. That could adversely affect the economy as consumers are shackled with higher mortgage interest payments and other loan rates.
The bond market can be a swift and cruel disciplinarian. Some $150 billion of U.S. government bonds are traded around the world in an average day. With computers and instantaneous communications links, worried investors--or speculators looking for an edge--can dump millions of dollars worth of bonds in the twinkling of an eye.
No one is more keenly aware of the influence of the bond market than Clinton, whose economic advisory team is liberally sprinkled with Wall Street-types. During the campaign and since his election, Clinton has attempted to distance himself from images that he is a free-spending Democrat who would wreak havoc with inflation and interest rates--and thus cause the value of outstanding bonds to plunge. Consider:
--In debate with President Bush and independent candidate Ross Perot, Clinton took pains to pledge that he would not interfere with the Federal Reserve Board, a bulwark in the fight against inflation.
--A week before the election, Clinton assured the Wall Street Journal--a direct pipeline to financial markets--that he had “given a lot of thought to the need to assure central banks, foreign leaders and world (financial) markets,” adding: “I am concerned about the markets fearing a Democrat.”
--And at Clinton’s first post-election news conference, the President-elect vowed to “set priorities” and “proceed with discipline” in economic matters, phrases calculated to assuage the jitters of bond investors.
“He’s saying all the right things, but the markets still see an inflationary bias in the coming Clinton Administration,” said David Jones, chief economist of Aubrey G. Lanston & Co., a New York securities firm.
It was that fear that prompted rates on 30-year Treasury bonds to climb about half a percentage point, to about 7.7%, since just before the November election when a Clinton victory became widely anticipated. The rates shot up after newspaper stories appeared suggesting that Clinton planned to embrace a broad stimulative fiscal package. Clinton and his advisers immediately said that such action was not planned, calming the bond markets.
“What is striking is that just a modest uptick in yields got the prompt attention of Clinton and his policy-makers,” said Edward Yardeni, chief economist of C. J. Lawrence Inc., a New York securities firm.
Yardeni, taking the measure of the growing clout of bond investors back in 1983, coined the phrase “bond vigilantes” to describe the new financial market disciplinarians who held sway over economic policy.
“By vigilantes, I mean investors who watch over policies to determine whether they are good or bad for bond investors,” Yardeni said. If the government enacts policies that seem likely to reignite inflation, he said, “the vigilantes can step in to restore law and order to the markets and the economy.”
Fear of a bond market selloff--resulting in higher interest rates since they move inversely to bond prices--will lead Clinton to avoid the traditional shotgun approach of a huge dose of traditional deficit spending to pep up the sluggish economy, economists predict. Rather, he will more likely select the more targeted approach of investment tax credits coupled with a restrained fiscal stimulus.
A mere 1 percentage point rise in long-term interest rates would not only add $20 billion to the government’s borrowing costs--further widening the deficit--but would also wreak havoc with key industries like housing and autos.
As a Democrat, Clinton will face unusual suspicion and scrutiny. For one thing, bond investors tend to be conservative and wary of Democrats. Perhaps more important, because Clinton will preside over a Democratic Congress, there is a “much higher probability” that whatever economic programs he proposes will be enacted into law, Hoey said.
Another reason the relationship between public policy and securities markets is more important now is because of the unusual nature of the economic recovery.
“This is an economy that is not behaving in a manner typical of postwar recoveries,” said John Lipsky, the chief economist of Salomon Bros. Inc., the scandal-tainted government bond powerhouse. Because of the huge overhang of consumer, commercial and government debt, lower interest rates have been a key ingredient in the ongoing process of healing debt-choked balance sheets.
“If the Clinton Administration’s policies lead to higher bond rates, the process of healing balance sheets will be slowed,” Lipsky said. “This means the Clinton team should very carefully tailor its policies to the problems that are actually holding back growth. Old-fashioned, Keynsian pump-priming may not do the trick. The bond market would rebel.”
Just what is this amorphous entity called “the bond market,” and who are its key players? In the old days, a firm like Salomon Bros. might have been the dominant force, but today the bond market “is so big and international and broad in scope that no single person or firm can influence it,” Jones said.
Rather, the bond market reflects the collective judgment of bond investors and speculators around the world. “It’s a fundamental calculation on the outlook for budget deficits, interest rates and inflation, five, 10, even 20 or 30 years out into the future,” said Jones.
Long-term interest rates “already incorporate some fears and expectations about the future,” Hoey added. “The market already even incorporates the fear of policy mistakes.”
But over the long term, Hoey said, “the markets are going to respond to reality--not dreams or nightmares.” Prices can run up and down in the short term on expectations and misperceptions, but any emotional blips “won’t persist very long because it is the nature of a market to correct itself. Crude self-interest will drive prices to their appropriate level.”
Another argument for stability, economists said, is the fact that Clinton has surrounded himself with financial and economic advisers who have the respect of many on Wall Street, including Robert Rubin of Goldman, Sachs & Co. and Felix Rohatyn of Lazard Freres.
Still, the next several weeks will be a volatile period for the bond markets as Clinton announces his economic appointments and they begin to hammer out economic policies. “Until the budget reshuffling is better defined, uncertainty will keep the markets unsettled,” said Lipsky.
