In the course of a few hours on Friday, some Americans' home-buying plans were upended, many businesses and cities suddenly faced higher borrowing costs and the stock market lost a stunning $190 billion in value.
All because the U.S. economy put more people to work in February, many of them in low-paying, temporary positions that probably aren't anyone's idea of a dream job.
On the surface, the panic that sent market interest rates surging and stock prices diving tells us something about the economy's health: that growth is accelerating, and with it, perhaps, wage demands and inflation.
But many Wall Street veterans concede that the markets' dive says less about the economy than about the trigger-fingered investment mentality of bond investors worldwide, people whose living depends on guessing hourly moves in interest rates that often are indicative of nothing.
Unlike the stock market, which is populated with personalities and admired success stories like Warren Buffett and Peter Lynch, most big bond investors are faceless to the general public and even to each other, except for a few names like global trader George Soros.
Yet they collectively control a market that is far bigger than that of stocks: U.S. Treasury securities alone total $5 trillion.
And they have enormous influence over the economy, as they demonstrated on Friday, pushing long-term interest rates up as much as a third of a percentage point after the government announced that the economy created 705,000 jobs in February. The rise in bond yields, in turn, sent the Dow Jones industrial average plunging 171.24 points to 5,470.45.
"The bond market overreacted to the jobs number. Then the stock market overreacted to the bond market," House Speaker Newt Gingrich (R-Ga.) said Saturday.
Even allowing for a politician's penchant for oversimplification, Gingrich's comment is essentially an accurate one. In fact, the bond market's role as a highly reactionary force in the economy has been growing since 1980, and has reached extraordinary proportions in the last three years, manifested in wild swings in interest rates.
Who determines where interest rates should be? Many Americans would say the Federal Reserve does. And as the nation's central bank, the Fed indeed controls short-term interest rates by raising or lowering the sum of money in the banking system.
However, long-term interest rates--on government, corporate and municipal bonds, for example, and on mortgage loans--are influenced only indirectly by the Fed. On any given day those rates are set by the market, meaning investors, such as pension funds, brokerages and mutual funds.
The nature of a bond, of course, is that the investor buying the security agrees to accept a fixed rate of interest from the bond issuer for the life of the bond--say, 6.5% a year for 10 years.
But that means the investor must be confident that a 6.5% yield won't end up a lousy return over that period. If market interest rates rise, or if inflation rises, the value of older bonds quickly erodes.
That is why the job surge reported Friday spooked many bond investors. They naturally associate stronger economic growth with rising interest rates and, potentially, rising inflation because a greater number of employed Americans means more consumers clamoring for goods and services.
John R. Williams, economist at Bankers Trust Co. in New York, says a basic rule of investing is: "When you shift the economy to faster growth, you don't want to own bonds anymore."
Or, at the very least, you want to quickly demand higher yields to compensate for the risk that market interest rates, and inflation, might indeed move up.
What has troubled many Wall Street pros--and average Americans--is that the bond market has become increasingly manic in recent years, extrapolating perceived shifts in the economy into dramatic interest-rate moves.
In 1994, as the Fed began to raise short-term interest rates from 30-year lows to slow an accelerating economy, the bond market reacted far more violently than the central bank had expected, driving long-term government bond yields from 5.8% to nearly 8.25%.
It was the worst one-year bond market reversal of this century, devastating buy-and-hold bond investors, such as Orange County's giant investment fund.
In part, bond market players' single-mindedness is a function of the generic nature of the securities they trade. Investors can have differing opinions about individual stocks, but with bonds the buy-or-sell decision usually hinges solely on interest rates' trend.
What's more, as technology has made for instant trading, and as the stock market has become the preferred vehicle of long-term-oriented small investors, bond investors' time horizons have shrunk.
"Investors don't buy bonds anymore," argues Jim Bianco, principal at Arbor Trading Group in Barrington, Ill. "Investors buy stocks. But someone has to buy all the bonds, so they end up with dealers, speculators and hedge funds."
The hedge funds, in particular, have been blamed for much of the bond market's moodiness in the '90s. Led by traders such as George Soros, hedge funds invest tens of billions for wealthy clients.
The funds tend to be extremely short-term traders and play markets' "momentum": When they perceive that bond yields are rising they will engage in complicated "shorting" trades that can drive yields even higher. When they perceive that yields are falling, they will aggressively buy bonds, helping push the trend (and profiting because higher-yielding bonds naturally become more valuable as rates on new bonds fall).
Late last year hedge funds were buying bonds in a frenzy, driving yields to two-year lows partly on the assumption that the U.S. economy would continue to weaken and that the Fed would continue to cut short-term rates.
But even before Friday's employment report, more bond traders had grown suspicious about the economy and about the Fed's intentions, and yields had been creeping higher in recent weeks.
Even so, the violence of the selling in the bond market on Friday showed that many investors were caught by surprise by the employment report.
"Investors buy into the consensus view," noted David Schroeder, a bond fund manager at Benham Management in Mountain View. "Investors get confident with the consensus and don't question it," he said--until it becomes obvious the consensus is wrong.
Now, the risk is that bond investors' panic will feed on itself as it did in 1994, driving long-term bond yields far higher than the economy's fundamentals justify.
As powerful as faceless bond traders have become, they enjoy that power only for one reason: because government, corporate and consumer borrowing has created a mountain of debt, and thus a mountain of debt securities that traders can manipulate.
With the federal borrowing binge of the last 15 years, the sum of U.S. Treasury debt outstanding has soared from $1 trillion to $5 trillion.
Because all bond investors have a vested interest in assuring that the value of their securities isn't destroyed by the higher inflation that rapid economic growth could bring, they have come to regard themselves as inflation "vigilantes": If the government and the Fed don't follow growth policies and inflation policies designed to keep interest rates and inflation low, traders stand ready to dump their bonds, sending yields up and creating a natural depressant on the economy.
Today, "In most of the developed world, it's the bond market that will ultimately control politics" and economic policy, said Howard Gleicher, manager at Palley-Needelman Asset Management in Newport Beach. For example, bond traders now "can produce pain for the politicians" by forcing them toward balanced government budgets, he said.
But he also notes, "Unfortunately, that pain has to go through ordinary people first"--by raising mortgage rates and business borrowing costs, and by braking the economy instead of allowing job creation and growth to speed up.
The surest way to take the reactionary bond market's power away, then, is to shrink the market by reducing debt and borrowing--which is what a federal balanced-budget plan would achieve.
It's no coincidence, analysts say, that bond investors have grown more edgy this year as budget talks in Washington have stalled.
Until the bond market Goliath can be brought down to size, says economist Irwin Kellner at New York's Chemical Bank, "the government has nobody to blame but itself" for the manic swings in market interest rates.