30-year bond yield plunges Drop in loan rates, some prices forecast, but no spending surge

Fed chairman's referral to deflation sparks rally

January 06, 1998|By William Patalon III | William Patalon III,SUN STAFF

Shoppers will see some lower prices on store shelves, and cheaper loan rates for cars and houses. But don't expect that to ignite a big burst of consumer spending, local experts said yesterday as yields on a benchmark long-term bond hit record lows.

Bond prices surged yesterday as investors scarred by the Asian economic crisis continued their flight into high-quality holdings like U.S. government bonds. That sent yields on the key 30-year Treasury down to 5.74 percent -- the lowest level since 1977, when regular sales of that bond began.

"It's very positive for all kinds of reasons," said Anirban Basu, an economist with the Regional Economics Studies Institute at Towson University. "First, it makes borrowing much easier. Second, the low interest rates we're seeing [are accompanied ++ by] relatively low inflation, which also bodes well for the consumer."

John C. Sweeney, who heads USF&G Corp.'s Falcon Asset Management subsidiary, said the Federal Reserve must ratchet down short-term rates by cutting the closely watched federal funds rate.

Indeed, in a speech Saturday to the American Economic Association, Federal Reserve Chairman Alan Greenspan actually invoked the seldom-used "D" word of economics: deflation, a period when the true prices of goods and services are falling. It was Greenspan's turnabout -- from inflation fighter to deflation fearful -- that touched off yesterday's rally in bond prices.

Yesterday, the two-year rate was 5.47 percent, close to the yield of the 30-year bond but enough below it to avoid the dreaded "inverted yield curve" that economists say portends a recession.

With an inverted yield curve, the uncertain near-term economic prospects force short-term rates above long-term rates.

Economists yesterday stood in agreement that no recession was in store in 1998.

Even so, several said there was tough sledding ahead for U.S. makers of big-ticket items such as automobiles -- particularly for domestic firms with Asia-based rivals. The dollar has strengthened substantially against foreign currencies such as the Japanese yen, making U.S. goods more expensive overseas and Asian-made goods cheaper here.

The upshot: U.S. firms will be hard-pressed to raise prices, even with a domestic labor shortage that some believe will force up wages.

This inability to boost prices, coupled with tepid spending by increasingly cautious consumers, will make for sluggish earnings increases in the year ahead, Merrill Lynch & Co. chief economist Bruce Steinberg predicted yesterday in his monthly conference call with investors.

Lower rates are typically good for the stock market. But investors looking for stock plays should avoid cyclical stocks and those of companies tied to basic industries, Steinberg said. Instead, search out opportunities in sectors such as pharmaceuticals or consumer products.

J. Patrick Bradley, director of economics and investing for Mercantile Bankshares Corp., said the best stock buys will be in the small-company arena. The reason: Many of those firms only sell domestically, serve carefully-carved-out niches, and often aren't facing down an Asia-based rival.

With their borrowing costs reduced, financial services companies such as banks should benefit from the lower rates. Mortgage companies are already seeing a big jump in the numbers of homeowners refinancing their homes.

But don't expect that activity to reach the torrid pace of the early 1990s, said Michael Carliner, vice president of economics for the National Association of Homebuilders in Washington. The typical mortgage loan outstanding right now carries a rate of 7.75 percent -- and the double-digit mortgages that were so prevalent in the early '90s are virtually nonexistent today, he said.

Even so, borrowers are more sophisticated now than a few years ago, meaning they won't necessarily wait for the 2 percentage-point spread that has been the trigger for a mortgage refinancing, Carliner said. "A lot of people today refinance with much smaller spreads," he said.

Pub Date: 1/06/98

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