Unemployment rate tides tossing Treasury bonds

The Economy

April 01, 1996|By Jay Hancock

THIS FRIDAY, the government will report monthly job results. Investors will be attentive. The last time this happened, they got clobbered.

If you lent the country $10,000 recently by buying 30-year Treasury bonds, your bundle is worth about $9,100 these days.

That's a $900 bath. About $350 of it was poured March 8. That was the day the Labor Department said U.S. unemployment fell from 5.8 percent to 5.5 percent.

About 705,000 more Americans held jobs in February than in the month before, the department said. It was the biggest dose of job creation in 13 years. The nation's workshops, stores, factories and warehouses were buzzing.

Wall Street, naturally, hated it.

The 3.5 percent plunge in the T-bond's value that day has been exceeded only once since 1979. How much is 3.5 percent? Imagine a 190-point dive in the Dow industrials stock index.

Come to think of it, you don't have to imagine it. The Dow did fall 190 that same day. (Actually, it fell more than 200 points at midday but closed with a decline of about 170.)

Wall Street throws raucous parties when economic news is bad and dons black armbands when Americans are getting hired. Not sporting, what? But it's based on old-fashioned pecuniary motives.

A stronger economy often brings higher inflation. Inflation corrodes bonds' worth. If your bond pays 7 percent, your "real" return will be greater if prices rise by only 2 percent than if they rise by 6 percent.

So if inflation threatens to rear its green, scaly head, you demand higher interest on your lent money to compensate. That's what happened to T-bonds. The interest yield on the 30-year bond has spiked from less than 6 percent in February to almost 6.7 percent.

Naturally, bonds bought at 6 percent are worth less now that new lenders can get 6.7. So if you resell the T-bond you bought two months ago, prepare to enter a fat capital loss on your 1996 tax report.

You'd think stock investors, who presumably favor sales, industry, commerce and Apple Pie, would cheer a growing economy. But thanks in part to a tax code that makes interest payments deductible, corporate America likes to borrow. Many companies' yearly interest payments equal half or more of their profit.

So if interest rates go up, company profits may go down. At least in the short term. And that's what Wall Street watches. Memorize those technical terms: "Short-term." "Profits." There. You've completed half the course to become a certified financial analyst.

Some economists have tried to reassure Wall Street by questioning the veracity of the February jobs report.

Oh, don't worry, they say. Things really aren't as good as you think they are.

One explanation, accepted by all, is that the 705,000 new jobs in February included compensation for January, when blizzards shut down many businesses and the nation actually lost jobs.

But the catch-up effect explains only part of what happened in February, many analysts now believe. Subsequent reports have reinforced the notion that the economy is accelerating. Home sales, retail sales, imports and factory orders are all rising healthily.

"We think the economy is showing more strength than just a rebound from bad weather in January," said Scott W. Reed, investment strategist for NatWest Securities in New York. "The scenario is that the Fed is going to be on hold for the next six months."

The Federal Reserve is the nation's central bank and the bond-market's Rottweiler. It controls short-term interest rates. It lowers rates and pumps money into the economy when commerce flags. It raises rates, restricts money and prompts layoffs when the business climate gets hot enough that inflation becomes a worry.

Until March 8, many analysts expected the Fed to reduce short-term rates one or two more times this year. The economy seemed sluggish. The Fed is always on cotillion behavior in election years, they said.

But the latest economic reports give the Fed a great excuse to freeze short-term rates for the balance of the year, analysts now believe. Fed Chairman Alan Greenspan reinforced those notions last week when he told Congress that high consumer debt and other hindrances "are not so strong as to seriously jeopardize the continued expansion of the economy."

The Fed could even raise rates by year-end, Mr. Reed said.

If only. Perhaps the March employment report, due Friday, will show commercial mayhem, layoffs, bankruptcies.

"The market is really going to be anxious to see this report," said Paul Boltz, chief economist for T. Rowe Price Associates in Baltimore. "And they will be on the lookout for revisions" showing that February's report of 705,000 new jobs was too rosy, he added.

But bond investors are betting otherwise. Both Mr. Boltz and Mr. Reed believe that T-bond yields could fall a little this year but will end 1996 in the 7 percent range. That'll mean higher borrowing costs for everybody -- companies, home buyers, car buyers.

The only way we'll see a 6 percent Treasury-bond rate and a 7 percent mortgage rate again soon, Mr. Reed said, is if lawmakers strike a deal to substantially cut the federal deficit.

"Don't hold your breath," he said.

Pub Date: 4/01/96

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