The bond market is poised to move toward higher prices and lower interest rates, but it faces two very different obstructions -- Congress and the weather.
Congress returns tomorrow from its Independence Day recess and will begin a month of serious and difficult legislating, starting with budget reconciliation.
The House and Senate versions of the bill are markedly different, and compromising won't be easy. If the compromises weaken deficit reduction, the bond market will retreat and interest rates will rise.
The weather, too, in a perverse way may have an adverse impact on the bond market. It has been raining every day since early May in some parts of the upper Mississippi valley, and some weather experts predict it won't stop for another month. Midwest farmers haven't lost so many crops to rain in nearly half a century, and economists have begun to raise their forecasts of food inflation.
Last Friday, though, the credit markets cheerily ignored these threats. The 30-year Treasury bond recovered from a morning decline -- caused apparently by news of higher soybean prices -- and rose enough to reduce its yield to 6.64%, its lowest level since the federal government began selling 30-year bonds on a regular schedule.
Moreover, the rate was slightly below the 6.66% level that had acted as a solid floor for several weeks. If economists thought the rain and floods meant higher food inflation, bond traders disregarded the warning.
Similarly, the credit markets maintained a positive attitude toward Washington and its ability to complete the tough legislating that lies ahead, and to reach the goal of reducing the federal budget deficit by $500 billion over the next five years.
In this trusting stance, the credit markets may take the easy way out, keeping an arm's length from analyzing a bill that involves delicate compromises for such important matters as the energy tax, cuts in Medicare, empowerment zones, and higher taxes on upper-income earners.
Deficit reduction bills passed both houses by close margins, and their differences are wide and deep. Achieving compromise and winning passage are going to be arduous, and there probably will be setbacks this month that will make the credit markets reel.
That's it. The Mississippi valley rains are so bad they likely will raise food prices, and Congress may botch deficit reduction. Despite the red flag of warning, there may be enough good news about inflation and the deficit to keep the bond market healthy. Apparently that's what most people in the credit markets thought last Friday.