Budget accord gives shaken market a lift

October 02, 1990|By Thomas Easton | Thomas Easton,New York Bureau of The Sun

NEW YORK -- The budget accord reached Sunday in Washington gave a positive jolt to the battered New York financial markets, with both stocks and bonds opening yesterday on a rare positive note.

The Dow Jones industrial average leapt 63.36 points, to 2,515.84, its best showing in months, after the enthusiasm sparked in the morning by the budget accord was further fueled by a $2.42-a-barrel decline in crude oil prices, to $37.09.

The bond market was similarly affected. Short-term rates dropped slightly and longer-term issues a little bit further.

The resolution of a credible budget accord, in addition to continued evidence of an economic slowdown, means it is only a matter of time before the Federal Reserve Board cuts interest rates, said Raymond Stone of Stone & McCarthy Research Associates, echoing other Fed watchers on Wall Street.

[Portraying the new budget accord as part of a pact between the administration and the Fed, President Bush effectively demanded yesterday that the Fed hold up its share of the bargain, the Los Angeles Times reported.

[The president said at a news conference in New York, "I would look to the Federal Reserve to lower the rates."

[But Fed officials indicated yesterday that they consider the deficit-reduction accord inadequate and that they have no immediate plans to nudge rates down when the Fed's policy-setting Federal Open Market Committee meets in Washington today.]

Any glee inspired by the government's attempt to rein in an exploding deficit was tempered by concerns about whether the agreement, reached by the administration and congressional leaders, will be approved by the rest of Congress and whether it will prove to be either enough, or, curiously, too much for the fragile economy.

The package adds new taxes, contracting the stimulative policies that have become the government's orthodox response to business slowdowns. But the negotiators were perceived as having little choice because of Washington's aggressive use of debt financing during the past decade, which left a vast and expanding deficit as a legacy.

"You are draining purchasing power out of the economy at the same time as it is falling into a recession," said Bruce Steinberg, senior economist at Merrill Lynch. "No industry benefits."

Far worse than the current package, however, would have been no package at all, he said. "The loss of confidence [in Washington] would have been devastating for the financial markets," Mr. Steinberg said.

Still, the impact of the package even in addressing the deficit will be limited. By the government's reckoning, only $40 billion will be trimmed from a ballooning federal budget shortfall that is forecast to reach a record $300 billion and may actually be far bigger.

"It's only a Band-Aid over a gaping wound," said Abby Cohen, market strategist for Barclays De Zoete Wedd Inc. "The budget deficit is extremely large and will probably get larger because of falling revenues and rising outlays for unemployment and the other similar benefits that accompany a slowing economy.

"Obviously, the market is enjoying [the agreement] today, but what's going on is a combination of relief from not going into sequestration and a technical rally from bearish sentiment that had gone to an extreme.

"It's nice to know the air traffic controllers won't be furloughed, but this is not the ultimate solution to the budget problem. It took many years to get into it and will take many years to get out."

The most vulnerable sectors appear to include the providers of discretionary goods, such as the travel industry, which also will be hit by higher taxes on fuel and airline tickets, and automobile dealerships.

Because the elderly may have to spend more on Medicare premiums, others who provide less essential services to that group may find their available income has declined.

Among the areas least likely to be affected are most of the industries directly targeted -- producers of liquor, tobacco, petroleum and luxury goods.

"Boozers will still drink, smokers will still smoke, energy users will still guzzle, and the wealthy will continue to buy expensive presents," said Brian Fabbri, chief economist at Midland Montagu.

"That's one of the reasons you tax them," said Richard Berner, an economist with Salomon Brothers. "They are less sensitive."

Though the benefits aren't direct, the accord may be the first step on the long road toward bringing down the federal deficit, a move that would lighten federal borrowing and lower all interest rates, said A. Marshall Acuff, chief strategist at Smith Barney Harris, Upham & Co.

That, he contends, would be bullish for growth stocks, which probably have an expanding stream of profits. As examples, he cited the major pharmaceutical companies and even Philip Morris, despite its tobacco business.

Second, lower rates would reduce pressure on the many overleveraged companies that must cope with faltering sales at the same time the cost of their debt is rising.

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