Market Place: Bond Market Gives Signals of an Upturn
By JONATHAN FUERBRINGER--NYTimes
May 15, 2001
T he bond market has not gotten a lot of respect recently as analyst after analyst has concluded that it is being led around by the stock market. When stocks are up, bonds are down,
and vice versa.
But the recent performance of bonds suggests that these investors are already looking ahead to an economic rebound and are not just following the beat of the stock market.
Over the last two months, longer-term Treasury securities have been selling off, pushing their yields higher, while shorter- term rates have held relatively stable. This split appears to
reflect a measure of confidence that the Federal Reserve will cut rates enough to get the economy on the rebound in the second half of the year. By this argument, the rising yields
on longer- term issues simply presage a move toward higher interest rates as the economy picks up steam again.
Rates on short-term securities, meanwhile, reflect the prospect of further rate cuts by the Federal Reserve, whose policy makers are expected to reduce short-term rates again, by a
quarter- or a half-point, when they meet today.
The yield on the Treasury's two-year note was 4.25 percent yesterday, just a bit above its average of 4.23 percent for the last two months. The yield on the 10-year note, though, was
at 5.43 percent, up from 4.76 percent on March 22. The spread between the yields on these securities is now 1.18 percentage points, twice what it was in March, and the widest it
has been since 1994.
Some analysts conclude that the sell-off among longer-term issues is not as negative as it seems. Bond market investors are merely looking to a brighter economic future.
"They have confidence that it is not going to be a long, drawn-out U-shaped downturn," said Louis Crandall, chief economist at R. H. Wrightson Associates, a research firm.
Mr. Crandall and others also spot an underlying concern about inflation, although he does not consider that the main reason longer-term yields have moved higher. There is little
concern that prices, which rose 2.9 percent at the consumer level over the last 12 months, will surge, he said.
Still, investors know that once an economic rebound is under way, Fed policy makers will turn their attention to curbing inflation and will probably begin to raise rates sooner than
they have during past recoveries.
The view that the economy is headed for recovery in the second half of the year has been helped along by the surprise cut of half a percentage point made by the Fed on April 18,
the fourth cut of that size since January, and by reports last week that showed retail sales were stronger than expected in April and consumer confidence rose to a four-month high.
Signs of economic strength remain mixed, however. A report released yesterday showed that industrial production declined 0.3 percent in April and has fallen seven months in a
row, a fresh reminder that the economy may not have hit bottom yet.
That report also helped swing investors to bet on a rate cut of half a percentage point today. At the end of last week, given the surprisingly strong economic data, investors saw a 50
percent chance of a cut that big, based on the price and yield of the federal funds futures contract. By yesterday investors saw a 70 percent chance of a half-point cut.
When Fed policy makers announce their decision early this afternoon, investors will be focused on whether the central bank will keep cutting. Policy makers could choose to keep
expectations of more rate cuts alive in their announcement. But if they quash this sentiment, both bond and stock investors are likely to be unhappy for a while since they both have
become dependent on Fed largess.
Policy makers will signal what they see in the near term.
In a statement after the intermeeting rate cut in April, the Fed noted that consumer spending, while flat, had held up rather well. But policy makers said that "capital investment has
continued to soften and the persistent erosion in current and expected profitability, in combination with rising uncertainty about the business outlook, seems poised to dampen
capital spending going forward."
"This potential restraint, together with the possible effects of earlier reductions in equity wealth on consumption and the risk of slower growth abroad, threatens to keep the pace of
economic activity unacceptably weak."
Since the release of the retail sales data on Friday, some analysts have argued that the strength in April was overstated. They noted that February and March retail sales were
revised downward and that while automotive sales rose last month, unit sales reported by the industry fell. The softer sales, these analysts said, may mean that the economy grew
slower than the 2 percent rate reported for the first quarter and that growth may be slow this quarter.
The industrial production report for April also helped underscore the fact that capital spending had not yet turned around. |
