Bonds lose their allure as inflation threatens

November 28, 1992|By Ian Johnson | Ian Johnson,New York Bureau

NEW YORK -- After having been a star performer whil interest rates dropped steadily over the past two years, the bond market is slowly losing its luster as rates steady and uncertainties about the Clinton administration linger.

The combination has been making bonds an unpredictable proposition, with conventional wisdom turned on its head by uncertainty over the incoming government.

In thin trading yesterday, the bellwether long-term Treasury bond fell more than $5 for each $1,000 face amount, pushing the yield up to 7.59 percent.

"There's some general nervousness about the incoming administration," said Stephen W. Gallagher, money market economist for Kidder, Peabody & Co. "It still seems to be all-systems-go for a fiscal stimulus."

The worry, Mr. Gallagher said, is that despite signs of a pickup in the economy, the new administration will pass an inflationary package to boost the economy.

Yesterday, the government reported that personal income rose 1 percent in October, about double the expected increase. But despite this good economic news, there remains no hint that the Clinton team will heed the signs of strengthening and back off plans for fiscal stimulus, Mr. Gallagher said.

This means that, in addition to the normal inflationary pressures of a growing economy, investors fear that a government spending package would heat up inflation -- and interest rates, thus eroding the value of their bonds.

This overriding fear of inflation helped confound the latest conventional wisdom, which had held that good economic news would ease pressure on the new government to jump-start the economy.

The theory had it that this milder spending program would not ignite inflation and so would protect the value of bonds.

But as yesterday's drop in bond prices showed, skepticism abounds that the new administration will be able to finesse a moderate growth package that won't be inflationary.

Until recently, bonds have been tremendous growth vehicles. The average bond mutual fund gained 65 percent in the five years that ended Sept. 30, compared with a 45 percent return for the average stock fund, according to Lipper Analytical Services.

Much of this gain came from falling interest rates, which made older, higher-yielding bonds worth more on paper. With the recovery strengthening and interest rates unlikely to go down, bonds are no longer the deal they once were.

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