Higher Interest Rates--and Higher Anxiety
Stocks tumbled as bond yields surged on Monday, as the latest strong economic data triggered the usual knee-jerk worries of tighter credit and higher inflation.
But while long-term Treasury bond yields neared the 7% level for the first time in a year, stocks’ declines were relatively modest from last week’s record levels--another sign, some analysts say, of the difference between the two markets’ underlying moods.
In the stock market, the ability of the Dow Jones industrial average to recover from a 140-point morning loss Monday, to close off 88.51 points at 5,594.37, suggests the bulls are still fighting to keep control.
In the bond market, however, optimists are increasingly in short supply as yields continue to climb, and as many bond investors worry that they have been completely blindsided by the economy for a third straight year.
The bellwether 30-year Treasury bond yield soared as high as 6.92% during trading Monday before falling back to close at 6.87%, up from 6.82% on Friday, when the government’s March employment report showed another surprisingly large gain in jobs.
Just two months ago the T-bond yield was at 6.14%, and many bond owners confidently expected the U.S. economy uto slow sharply, dragging yields even lower.
Now, a daily survey of professional trading advisors nationwide by Market Vane Corp. of Pasadena shows that only 32% say they are bullish on Treasury bond futures, meaning they believe that interest rates will soon decline. The bullish percentage is the lowest since 1994, when the Federal Reserve Board was in the midst of tightening credit to slow the economy.
For bond investors, predicting the economy--and bond yields’ reaction to its ebbs and flows--has become an ever-more-humbling exercise.
Friday’s employment report said the economy created 140,000 jobs in March--triple the number most economists had expected. That followed the shockingly robust February employment on March 8, and a host of other economic reports since, many of which have made it clear that the economy isn’t falling out of bed.
Most striking has been the strength of the consumer sector: Home and car sales have exceeded expectations in recent months, and consumer borrowing also remains robust--despite the widespread belief that Americans are “tapped out” financially, unable or unwilling to add to their debt burdens.
“The consumer is not tapped out,” argues James Glassman, economist at Chemical Securities in New York. Although absolute debt levels appear high, he said, many consumers don’t find their debt service--their monthly payments--unreasonable.
What’s more, the economy’s ability to generate more jobs gives spending power to “new’ consumers while bolstering consumer confidence in general.
Yet some bond pros still contend that the strength in recent economic data either is fluky or overstates the economy’s health.
Bruce Steinberg, economist at Merrill Lynch & Co. in New York, says job growth in the first quarter of this year averaged 206,000 per month, below the 226,000 of first-quarter 1995. And last year, he says, “the statistically inflated job gains of winter were washed out during the spring. We believe a similar pattern could develop this year.” In other words, job creation should tail off, which should mean that the bond market will calm down, allowing yields to fall back again, he says.
But what worries many bond investors is how miserable their record of calling market trends has been in recent years. In 1994, most experts failed to correctly gauge the economy’s strength, or the extent to which the Fed would have to raise short-term interest rates to finally slow business and consumer spending.
Then, in 1995, many investors were reluctant to lock in yields even as they began to fall, because the consensus view was that the economy would remain robust and that the Fed was a long way from beginning to ease credit again. Instead, the Fed began to cut rates last July.
This year, investors’ collective mistake appears to be that they trusted too much in the Fed. When the central bank eased short-term interest rates on Jan. 31--the third cut since last July--many bond pros wrongly assumed that the Fed must have had irrefutable evidence that the economy would stay weak.
“You could argue that the Fed fueled the mentality” about the economy’s supposed weakness, said Glassman. Indeed, many experts now believe that Fed Chairman Alan Greenspan must rue the Jan. 31 rate cut.
“I thought it was a mistake,” said Wayne Angell, a former Fed member and now an economist at Bear, Stearns & Co. He believes Greenspan should have paid more attention to rising commodity prices than to other data that suggested the economy remained anemic.
But with bond yields already back to their levels of last spring or summer, how much higher should they go, even if the economy remains on a decent growth track?
Analysts say the problem now is that the bond market’s negative mentality can feed on itself. With short-term traders in control of the market at any given moment, additional signs of economic strength--or of higher inflation--could easily push the market further in the direction is has already been headed in recent months, meaning toward higher yields.
Although some investors might be tempted to think that the preponderance of bearish advisors in the Market Vane survey is a “contrarian” sign that it’s time to buy bonds, in fact the bears also dominated in the spring of 1994--and rates continued to climb from there, til November of that year.
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Few Bond Bulls
The percentage of professional trading advisors who are bullish on Treasury bond futures-- expecting lower interest rates-- is at its lowest since 1994, according to Market Vane Corp.’s daily survey.
Percentage of advisors who are bullish, month-end data and latest:
Monday: 32%
Source: Market Vane Corp.
* STOCK SLIDE
Market ended broadly lower but rallied in late trading, as smaller issues and tech shares drew buyers. D3
