The municipal bond market has regained its composure, and tax-exempt bonds have retraced more than half the ground they lost between mid-October and Thanksgiving. It wouldn't be surprising to see rates decline soon to new lows, putting them at their lowest levels in 20 years.
The main impetus behind rising bond prices and declining bond yields last week was new evidence that inflation - the ruination of fixed-income investments - is remaining in check. Last Thursday, the Labor Department reported that wholesale prices were flat in November, and on Friday it disclosed that retail prices had risen 0.2% last month. Over the last year, wholesale prices have inched up only 0.3%, and consumer prices, 2.7%. Over the last six months, consumer prices have risen at a rate of just 1.8%, Federal Reserve Board Chairman David Mullins noted last Tuesday as he spoke at a conference sponsored by the American Enterprise Institute.
All these numbers should make bond investors happy, and indeed, the bond market reflected a more positive attitude most of the time last week. The yield-to-par call on The Bond Buyer's daily municipal bond index dropped 25 basis points from Friday, Dec. 3, through Thursday, Dec. 9. The MBI yield had climbed 63 basis points from 5.33% on Oct. 15 (its low for the year) to 5.96% on Nov. 23. Since then, it has come back down 36 basis points to 5.60%.
With higher income tax rates about to go into effect, continued low inflation, and the Federal Reserve poised to raise short-term interest rates if prices don't behave themselves, the market should begin the new year in good shape. It's difficult to see why the Fed needs to tighten credit in the months ahead, but the central bankers may decide to err on the side of tightening simply to show the world that they are doing something. If they do nudge short rates up, bonds should benefit.,
Major corporations' effort to raise productivity and profits will also help. RJR Nabisco last Tuesday announced plans to eliminate 6,000 jobs, or almost 10% of its work force. A day later, Xerox Corp. disclosed plans to cut at least 10,000 jobs, or 10% of its employee roster. As long as cuts continue, the long-term bond market should remain confident, especially with a declining federal budget deficit and stable prices.
The business recovery began in April 1991, but it doesn't seem that old, largely because of all these corporate cutbacks. The quality of the recovery is different this time, partly because of the end of the Cold War and the emergence of cheap labor worldwide. All this helps explain why the credit markets have regained a sensible degree of optimism lately.