U.S. Bond Market Investors Brace for Worst, Even as
Inflation Remains Tame
By Beth Williams
Bond Market Braces for Worst, Good News Aside: Rates of Return
New York, Dec. 10 (Bloomberg) -- Investors in the $3.2
trillion Treasury market are bracing for bad news, even though
they've gotten their share of good tidings lately.
A report today showing producer prices were unchanged in
November excluding food and energy -- a sign of tame inflation
that would typically spark a frenzy of buying -- prompted only
moderate gains in government debt.
''The market is fearful that the worst is yet to come and an
occasional good number like this has a muted impact,'' said Greg
Habeeb, who manages about $2 billion of bonds at the Calvert
Group in Bethesda, Maryland. ''Things could change.''
U.S. 30-year bonds climbed 21/32, or $6.56 per $1,000 face
amount, to 99 15/32 after today's report, which showed the
producer price index rose 0.2 percent overall. Yields fell 5
basis points to 6.16 percent. By contrast, a similar report in
August sparked a rally that sent bonds up almost 1 1/4 points.
It was the same story earlier in the month, when figures
showing subdued wage gains last month and the biggest gains in
productivity in seven years in the third-quarter, failed to
produce more than one-day spurts.
It's not enough for bond investors to know that inflation
and the ingredients that typically goad it along -- such as
rising job costs -- are behaving themselves now, even with the
economy's strength. They want assurance that inflation, which
eats into the value of a bond's fixed payments, isn't poised to
spiral higher before turning bullish on Treasuries.
Caution Reigns
With the economy poised to break a record run, the jobless
rate at a 30-year low, and surging U.S. stocks fueling consumer
spending, that assurance is hard to come by. Investors probably
won't get much comfort from next week's consumer price report,
either, even if it shows inflation isn't quickening too much.
Already, the Federal Reserve raised its target for overnight
lending between banks three times since June in an effort to curb
growth before it results in higher prices on goods and services.
Fed officials have hinted they may be prepared to raise interest
rates again on signs of further tightness in the jobs market,
which might lead to higher wages that could spur inflation.
''I would err on the side of caution,'' said Kirk Hartman,
who oversees $100 billion as chief investment officer for fixed
income at Bank of America Investment Management in Los Angeles.
Hartman said he favors corporate, mortgage and other non-
government securities that offer higher yields than Treasuries,
This strategy helps boost performance at times when government
yields aren't moving much, or on the rise -- like now.
After climbing more than a percentage point since the start
of the year, 30-year yields have been stuck in a range of about 6
percent to 6.40 percent the past three months. Losses for the
year are at 9.3 percent, taking reinvested interest into account.
Fed funds futures -- the futures market's closest match to
the central bank's target -- indicate investors put the odds of a
quarter-point rate increase at about 70 percent for the Fed's
Feb. 2 policy meeting, based on an implied yield of 5.66 percent
on the February contract. By April, a rate increase is fully
priced in.
Inflation 'Building Blocks'
''I don't think the Fed will wait to see the whites in
inflation's eyes before moving next,'' said Todd Finkelstein, who
helps handle $425 million at Advest Group Inc., in Boston.
''There's no real pressure on wages but the building blocks
continue to be put in place for a pick-up in inflation.''
Finkelstein said Treasuries could get a lift in the weeks
ahead, keeping 30-year yields near 6.15 percent, as traders seek
safer investments to avoid problems stemming from possible
computer breakdowns at the turn of the year. Those concerns will
also likely keep the Fed from raising rates when officials meet
Dec. 21, analysts said.
That said, Finkelstein sees any gains in the market as only
temporary, which is why he has set up his portfolio so it will
perform better than his benchmark if rates rise. He expects at
least one more Fed rate increase next year and 30-year yields to
rise as high as 6.70 percent.
Rate Rise Series?
Some investors fret the Fed's inaction this month, while
understandable, may further increase the chances for quickening
inflation and the need for even more rate increases in the
future. While not registering the double-digit gains of 20 years
ago, inflation is still on the rise this year.
Next week's report will probably show consumer prices rose
2.4 percent in the 12 months ended in November, compared to 1.6
percent for all of 1998. That would put 30-year yields at 3.76
percent after inflation. For so-called ''real yields'' to match
the 4 percent average of the past five years, 30-year yields
would have to be at 6.40 percent. Yields could climb even higher
should investors anticipate inflation will accelerate as the
economy steams along, investors said.
''We're still cautious,'' said Jim Snyder, who invests $3.8
billion in bonds for American Express Asset Management in
Minneapolis. ''The risks are still toward rising yields based on
the strength of the economy.'' |
