A Rates Fixation
Buyers rushed to lock in yields on bonds on Monday, sending long-term yields to their lowest levels in at least 20 years, as sinking commodity prices and a deflation warning from Federal Reserve Board Chairman Alan Greenspan suggested that even lower interest rates might be ahead.
Another plunge in Asian currencies and stocks Monday also set the tone for heavy buying of U.S. Treasuries, in a fresh “flight to quality,” analysts said. Asia’s sell-off continued today.
The yield on the 30-year Treasury bond, a benchmark for long-term interest rates, tumbled from 5.82% on Friday to 5.73% on Monday--eclipsing the previous 1990s low of 5.77% set in October 1993 and marking the lowest yield since the government began regularly issuing 30-year securities in 1977.
Yields on shorter-term securities also slumped amid a buying wave that many analysts believe won’t ebb soon.
“I don’t know if you’d call it a buying panic, but clearly there is a real rush here” into fixed-rate securities, said John Queen, bond portfolio manager at Hotchkis & Wiley in Los Angeles.
Meanwhile, stocks ended mostly higher, although some traders said the market wasn’t quite sure what to make of bonds’ rally. Although lower interest rates usually help support stock prices, the threat of deflation--which could mean deflating corporate profits as well as falling prices for goods and services--concerns Wall Street’s bulls.
The Dow Jones industrial average inched up 13.95 points to 7,978.99.
Worries about the potential for deflation, or widespread declines in prices in the economy, have been mounting since Asia’s economic crisis erupted late last summer. With their currencies sharply devalued, exports from many Asian nations have become dramatically cheaper for American buyers.
While that is good news for consumers, some economists believe that cheaper exports could set off a wave of competitive price cuts, threatening corporate profits. What’s more, Asia’s economic woes are expected to slow global growth overall, raising the risk of more widespread price-cutting as companies fight for sales.
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Greenspan, in a speech on Saturday to the American Economics Assn., did not predict that such a deflation wave is imminent. But he spent much of the speech warning of the perils of deflation--not so much in prices of goods or services, but in prices of assets, such as stocks and real estate, which could be dragged down in advance of, or in tandem with, weakness in the economy.
“Inflation has become so low that policy-makers need to consider at what point effective price stability has been reached,” Greenspan said.
The tone of the speech convinced many bond investors that Greenspan, who has spent most of his career worrying about taming inflation, now is concerned that the greater risk might be deflation.
And because the Fed has just one potential weapon to battle deflation--lower rates, which would stimulate economic activity--the bond market on Monday saw Greenspan’s comments as a hint that the Fed may soon cut its benchmark short-term rate, the federal funds rate, now 5.5%.
That, in turn, could allow longer-term rates to fall much further.
“I think the Fed is now poised for an easing” of credit, said Scott Grannis, economist at Western Asset Management in Pasadena.
In fact, yields on Treasury notes of five years’ term and less are already trading below the federal funds rate. The 5-year T-note yield slid to 5.46% on Monday from 5.61% on Friday.
That suggests investors are already building a Fed rate cut into their assumptions.
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Other analysts, however, believe it’s more likely that the Fed will merely sit tight, keeping short rates at current levels.
In any case, “It’s clear that the Fed is not going to do anything” to push interest rates up soon, said William Griggs at financial consulting firm Griggs & Santow in New York.
Meantime, the bond market’s current rally, which has been gaining steam since summer, also is being fueled by other factors, experts say:
* Key commodity prices continue to decline, putting further downward pressure on the already low U.S. inflation rate. On Monday crude oil futures sank 54 cents to $16.89 a barrel, the lowest in more than two years, as warm weather in the Northeast suggested slackening energy demand, and as Iraq prepares to begin exporting oil again.
Gold, the classic inflation hedge, fell again on Monday, with near-term futures losing $6.70 to $282 an ounce--an 18-year low.
Even without actual deflation in broad price gauges such as the consumer price index, a minuscule rise in inflation means that real bond returns--that is, after-inflation returns--are historically high.
At 5.73%, the real yield on the 30-year T-bond is 3.9%, subtracting the 1.8% rise in the consumer price index over the past year. Historically real yields have been more in the range of 2% to 3%.
“If there’s no inflation, 4% to 5% [bond yields] would clearly be good yields” to be earning, judged historically, said Hotchkis & Wiley’s Queen.
* Asian financial markets have weakened again in recent days, indicating the crisis there isn’t over. On Monday, the currencies of Indonesia, Thailand and Malaysia hit new lows versus the dollar, and most Asian stock markets also sank. That continued early today: Malaysia’s main share index was off 3.4% at midday today after diving 4.4% Monday; Hong Kong’s key index, down 3.5% Monday, was off 1.3% at midday today.
The dollar jumped to a 5 1/2-year high versus the yen on Monday.
With investors still frightened about prospects for Asian markets, the U.S. Treasury bond market becomes a natural safe haven for money, analysts point out.
* More U.S. investors appear to be interested in owning bonds as a hedge against worse-than-expected economic weakness, and/or a severe stock market decline.
After three years of sensational gains in the stock market, the notion of taking some stock profits and investing them in safer fixed-income securities may simply seem prudent to many investors.
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How low can bond yields go? “We’ve got a great shot at a 5% yield” on the 30-year T-bond, says economist Grannis.
Many other analysts are more cautious, warning that it isn’t at all clear that U.S. inflation is about to collapse to zero, or become actual deflation. Indeed, inflation in wages, at least, has continued to accelerate.
Still, given the intensity of bonds’ rally in recent months, “this has become a freight train going down the track,” said Gerald Guild, bond trader at Advest Group.
As for the stock market, however, whether lower bond yields will help stoke a new rally is still an open question.
Wall Street’s great fear is that a continuing decline in yields could convince stock investors that deflation will become reality soon--crushing corporate profit margins. That could potentially outweigh the benefits of lower rates.
Fourth-quarter corporate earnings reports will begin to roll out starting next week. That may provide a crucial test for stocks.
On Monday, the Dow rallied early in the day as bond yields fell, but sold off later. Even so, breadth was positive: Winners topped losers by 1,659 to 1,417 on the New York Stock Exchange and by 2,466 to 1,903 on Nasdaq.
And the Nasdaq composite rose 0.8% to 1,594.12, as some battered tech stocks rebounded.
But the Dow utility stock index, which has been rallying with bonds in recent months, was hit by profit-taking. It fell 1.1%.
Oil-related stocks plunged with crude prices. Chevron sank $2.25 to $75.69, Halliburton dropped $3.25 to $47.88 and Western Atlas was off $2.25 to $69.50.
Market Roundup, D10
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* LOOKING DOWNWARD
Will deflation fears supplant inflation fears? Some economists think so. A1
(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)
Bull Market for Bonds
Long-term bond yields plunged on Monday after Federal Reserve Board Chairman Alan Greenspan, in a weekend speech, focused on the deflation threat in the economy. Greenspan’s concern suggested to Wall Street that the Fed’s next move may be to cut interest rates. Even without the Fed’s help, bond yields have been tumbling as commodity prices have slid--reducing inflationary pressures--and as more investors have sought the relative safety of bonds to hedge their stock market bets.
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Long-Term Yields Plummet...
30-year Treasury bond yield closes and latest:
Monday: 5.73%
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...as Commodity Prices Tumble...
Crude oil futures, per barrel, monthly closes and latest:
Monday: $16.89
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...and as Bond Fund Inflows Surge
Bond mutual fund net cash inflows, by quarter in billions of dollars:
$14.1*
* October and November only
Sources: Bloomberg News, Investment Company Institute
