Here's another perspective on the bonds influence on interest rates and ultimately equities (Bloomberg Personal Finance, March '99)
The Golden Rule: Bullion's decline is bullish for Treasuries, signaling more Fed rate cuts.
bloomberg.com
The bond market's favorite economist is telling investors that the Treasury
rally of 1998 isn't over, and the price of gold is a major reason.
Ed Hyman-ranked No. 1 economist on Wall Street in Institutional Investor polls
for the past 19 years-points out that since the 1980s, the final Fed-funds rate cut
in a series of reductions has been preceded by a spurt in gold prices, reflecting
market expectations of growth and faster inflation. Yet at $287 an ounce in
January, the metal had not risen much from a 19-year low of $271.13 recorded
on August 28, 1998. That, Hyman says, suggests that the Federal Reserve may
not be finished reducing interest rates after three cuts from September through
November last year. As a result, U.S. 30-year yields, which were 5.22 percent
as of early January, may fall farther as well.
''We're calling for the Fed to ease a couple more times and for bond yields to
go to roughly 4.5 percent,'' says Hyman, chairman at International Strategy &
Investment Group.
Hyman's forecast is based on a whole series of market and economic
indicators that he says are sending out bullish signals for bonds. In addition to
stagnation in gold, he cites slumping steel prices, depressed stocks of
companies whose fortunes are closely tied to the economy, and wide yield
spreads between corporate and U.S. government debt.
Typically, improvement in these measures indicates a strengthening economy.
Higher prices for steel, gold, and other commodities signal renewed demand
for these materials, suggesting expectations of economic expansion. In the
case of gold, long considered an inflation hedge, heightened demand also
reflects fears of the rising prices that in the past have accompanied robust
growth. Similarly, gains in so-called cyclical stocks-such as those of steel and
paper companies-indicate expectations of rising profits in these industries as
the economy grows. And a narrowing of the difference between yields on
corporate and government bonds points to assumptions that there will be fewer
defaults as corporate credit quality remains stable or strengthens in the
improving economic climate.
Just the opposite of these events occurred in 1998, pointing to potential
economic weakness that may put a drag on U.S. growth and necessitate more
Fed cuts. Gold prices, as noted above, remained low, while those for steel fell
more than 40 percent. Meanwhile, the stocks making up the Standard & Poor's
index of paper and forest-product companies gained just 3.95 percent,
including reinvested dividends, compared with gains of more than 28 percent
on the broader S&P 500 index. And the average yield spread above
comparable Treasuries on A1-rated 10-year corporate industrials was about
0.83 percent, up from 0.52 percent a year ago, according to an index tracked by
Bloomberg.
''There's a risk on the downside'' reflected in gold's low price and the other
indicators, notes Hyman. ''There are uncertainties, unanswered questions
about how bad things might get'' in the struggling economies of Latin America,
Asia, and Russia. Continuing troubles in those areas might curb U.S. growth,
pushing the Fed to further reductions.
Many investors share his view. ''I'm in that camp," says Scott Grannis, who
helps oversee about $50 billion at Western Asset Management in Pasadena,
California. Like Hyman, Grannis considers the depressed prices of gold and
other commodities such as oil ''good sign[s] the Fed hasn't stopped'' cutting
rates. ''The easing has just begun and has a ways to go,'' he concludes.
Others aren't so sure. Garth Nisbet, who manages $750 million at Crabbe
Huson Group in Portland, Oregon, feels the fact that gold has risen from its
August low may mean the worst is over-even though the rise has so far been
slight and further strengthening could take a while. ''Gold has gone from a big
downtrend to maybe a bottom," he says. ''It's not obvious to me that it's telling
you yields are moving lower.''
What's more, some contend that the recovery in stocks through the beginning of
January, strength in U.S. housing and employment, and resurgent consumer
confidence all argue against another rate cut anytime soon. A large swath of the
market agrees, judging by the futures contracts for the Fed-funds rate. (These
contracts can be found on the Bloomberg Website by clicking on Futures under
the green Market key and scrolling down.) Subtracting the listed price from 100
gives you the Fed-funds rate the market expects to be in effect when the
contract expires. If this rate is lower than the present one, the market is betting
on the Fed to loosen; if higher, a tightening is predicted. In January, the implied
yield on the April contract for one-month Fed-funds futures-4.68 percent,
compared with the actual rate of 4.75 percent-suggested that only a minority of
investors saw another 25-basis-point rate cut at either of the next two Fed policy
meetings, on February 3 and March 30.
Hyman, however, stands pat. He points out that the so-called recovery in gold
was weak, and its price has since fallen again. With other commodities still in
the doldrums, investment-grade corporate-bond spreads near their widest point
in at least a decade, and inflation tame, history, Hyman feels, points to more
cuts in the offing, though the timing is unclear.
Don Ross, chief investment officer of National City Corp. in Cleveland, where he
oversees $23 billion, agrees with this reasoning. And he joins Hyman in calling
for more gains in U.S. 30-year bonds. Says Ross: ''The long-bond yield has not
seen its lows.''
For the futures contracts for the Fed-funds rate, see www.bloomberg.com.
-- Beth Williams covers the government- and corporate-bond markets for
Bloomberg News.
Company Guide
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Yesterday, I listened to 2 different analysts on CNBC, one from Value Line, stating that the volatility in the equities was related to unwinding the current bond offerings. The other analyst (sorry can't remember who), spoke with quite a bit of conviction and sense of authority stating the interest rates would continue to come down.
Laura |
