Long-term Treasury bonds yielded 5.81% on Oct. 20, 1993, and they yielded 7.62% last Monday. That's as increase of 181 basis points in less than seven months, a big move for such a short time and a jump that has yet to be convincingly explained.
Early in February, the Federal Reserve raised short-term interest rates and bond prices plummeted. Last week, the Fed did into raise short-term interest rates and bond prices plummeted. First the Fed surprised the bond market, and then it disappointed the market. Either way, it helped push interest rates higher.
The thrust behind higher rates has been the Fed's determination to nip inflationary expectations in the bud, and that's unusual work. Not everyone's inflationary expectations are the same, especially when wholesale prices are declining and retail sales are too. Like the Shadow, the Fed apparently thinks it knows what evil expectations lurk in the minds of men, and it has moved preemptively to strike them down.
The bond market seems most influenced by the healthy growth in jobs this year. Employment rose by 267,000 in April, and the increase would have been about 70,000 higher but for distortions caused by A Teamsters strike. For the year to date, nonfarm jobs are up about one million, an interesting statistic in view of all the gloomy predictions that accompanied last year's income tax increase. April's job growth is what drove the long bond's yield to 7.62% last Monday. Still, we're not convinced that wages are rising, and rising wages rather than the increased number of jobs ought to be the labor statistic that affects the bond market.
We guess that speculative trading has intensified this year's swings in prices and yields. For that reason, testimony by three big guns - Gerald Corrigan, former president of the Federal Reserve Bank of New York; Richard Breeden, former chairman of the Securities and Exhcange Commission; and Dennis Weatherstone, chairman of J.P. Morgan & Co. - raised our suspicions last Tuesday. All three told Congress that no new legislation is needed to regulate derivatives, but they seemed to be protesting too much. Breeden said "the sky is not falling," but he also said sunlight is a powerful disinfectant and some stronger doses might help prevent abuses. More "transparency" is needed, he said, meaning stricter accounting, valuation, and disclosure requirements.
So goes the new, more highly leveraged bond market of 1994. Bond prices are more volatile and yields are higher than we would have though at all probable.
