Some bond rate mumbo-jumbo for you to digest. Let me know if you think it means anything.
Despite Jitters, Some Analysts
See Hope in the Bond Market
By GREGORY ZUCKERMAN
Staff Reporter of THE WALL STREET JOURNAL
NEW YORK -- Amid the growing clouds covering the bond market, some see a ray of sunshine trying to break through.
A jump in oil prices hurt the bond market once again Tuesday, sending prices down and thus yields up. But an unusual quirk has suddenly emerged within the bond market that some bulls interpret as an early sign that the worst could soon be over for bonds.
Some medium-term bonds, such as 10-year and seven-year Treasurys, now yield more, or the same as, the benchmark 30-year bond. This isn't supposed to happen.
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For example, the seven-year Treasury note traded at a yield of 6.767% late Tuesday, and the 10-year Treasury at 6.743%. But the 30-year bond also yielded just 6.745% (and for most of the day was below both securities).
Normally, it is just the opposite. Investors usually demand a higher yield on the 30-year bond to compensate them for the risks of lending out their money for the long haul. No more.
What happened Tuesday is known as an "inversion" of a key part of the yield curve. This is the first time this has happened in more than five years.
But it isn't just a technical development. It means that investors are getting more interested in long-term bonds, as they bet that the Federal Reserve will succeed in stamping out signs of inflation in coming months and that rates could soon plateau.
Under such a scenario, long-term bonds, such as the 30-year bond, would outperform shorter-term securities, such as the 10-year and seven-year Treasurys. The yields are inverting as yields on medium-term securities climb faster than those on long-term securities. While rates could go higher, even hitting 7% in the weeks ahead, the damage could be stemmed at that point, as rates plateau, bullish traders say.
"The market feels the Fed's going to do what's necessary [to fight inflation], and the inversion tells you we may be getting close to the lows," says Irvin Goldman, head of U.S. interest-rate and derivatives trading at Credit Suisse First Boston.
There's a rub in the bullish theory: A host of technical factors are distorting bond prices, suggesting that the inversion may have to last a while before it becomes a true bullish sign.
For one thing, the Treasury Department last week announced it would soon begin buying back Treasurys with long maturities, helping to keep rates on all kinds of long-term Treasurys lower than they would otherwise be.
"Anticipation of buybacks by investors is a large factor" in the inversion, Mr. Goldman of First Boston said. A more-bullish sign would be if two-year notes yield more than 10-year notes, he said.
Further, the 30-year bond has gotten a bit of a boost from a dwindling supply of such securities, as the Treasury Department reduces its 30-year bond auctions, because of the rosy budget outlook. Declines in European bond markets have also weighed on the 10-year note. Most European benchmark securities are 10-year notes, and the weakness overseas has pressured medium-term U.S. issues.
Meanwhile, many investors who had purchased short-term securities before year end, in a flight to safety ahead of potential year-2000 related computer glitches, are now selling those securities. At the same time, a growing number of companies and government agencies have been selling bonds in recent days. To prepare for these deals, investors as well as Wall Street traders have been selling 10-year Treasurys, the security most often used to hedge their interest-rate risks.
"It's more difficult to make the bullish argument until a complete inversion of the yield curve occurs," says Livingston Douglas, president of Mountain View Advisors LLC.
Still, hopeful traders pointed out that the last time yields on 10-year and 30-year Treasurys inverted, a rally soon began.
"It's the beginning of a bullish sign," says Chris Fitzmaurice, senior government bond trader at Salomon Smith Barney. "While there could be more damage ahead, yield curves usually invert near the peak in rates."
There is good reason why some traders are encouraged by the yield-curve inversion. The last time this happened, in late December 1994, it came after a brutal year for bonds, caused by six rate increases by the Fed. While the Fed raised rates again in February 1995, the bond market was already rallying at that point, and the Fed subsequently cut interest rates twice in the second half of 1995.
Similarly, the current yield inversion also comes on the heels of a brutal year for bonds in 1999. And it suggests to some that the Fed is likely to raise rates at least once in the first half of this year, but that may be enough to slow the economy, knock inflation out for the count and spark a rally for bonds, as investors rejoice over the final Fed rate increase.
So should stock and bond investors rush into the market now, to take advantage of any peak in interest rates signaled by the inversion? Not so fast, some analysts warn. While bond investors are beginning to come around to the view that anticipated Federal Reserve interest-rate increases could head off any bout of harmful inflation, the moves will likely keep pressure on bond prices, at least until the last of the rate increases is in sight. In fact, it may take months of bond-yield inversions before bonds start to rally.
Meanwhile, stock markets tend to do poorly when the yield curves invert, according to historical data compiled by Mr. Douglas, as rising short-term bond yields attract cash from the stock market and pinch corporate profits by raising borrowing costs.
"Stocks live and die on liquidity, and inversions are usually accompanied by a withdrawal of liquidity" as the Fed raises rates, Mr. Douglas said. |
