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ALL SHOOK UP
After watching the U.S. Treasury market come unglued on Mar. 1, Mark Turner, chief investment officer for Putnam Investment Management's fixed-income group, arrived at his downtown Boston office at 2:30 the next morning prepared for the worst. His expectations were quickly met.
In Tokyo, bonds were turning in their worst day since 1988. In Paris, bond-futures selling grew so intense that trading had to be suspended. The Bank of England was stepping into the market to supply hard-pressed London bond dealers with cash. And as the new day began on Wall Street, the selling showed no sign of letting up. Sighed the weary Turner: "We're having a pretty good shakeout."
You can say that again. Around the world, despite tremendous ups and downs, the bond-market retreat that many traders hoped they'd never see is rapidly unfolding (charts). In the U.S. alone, yields on 30-year Treasuries have climbed more than half a percentage point since the start of the year amid signs the U.S. economy may be expanding more rapidly than expected. In Japan, rates have climbed a half-point despite flat consumer prices and little evidence of a recovery from the worst recession since World War II. It's much the same story in recession-bound Germany, where interest rates have shot up a full point. Yields have risen even more than that in Britain. And global stock markets are in turmoil (page 28).
Traders attribute the worldwide rate surge to everything from confusion over Federal Reserve Chairman Alan Greenspan's intentions after raising the Federal Funds rate on Feb. 4 to the dollar's recent slide against the Japanese yen as Washington and Tokyo battle over trade.
FUND EXODUS. Making things worse, analysts and traders say, is massive liquidation by mega-investor George Soros and other managers of hedge funds that are facing margin calls from banks around the world. Traders say these highly leveraged funds, as well as big U.S. pension funds that invested tens of billions in cash abroad last year, are dumping Treasuries to cover their losses in less liquid markets overseas. Industry sources speculate that Bankers Trust New York Corp. lost close to $100 million during a few days in late February and early March. Bankers Trust says it has been profitable this year and declines to elaborate.
The big market losses could be only the first sign of trouble. Traders and executives say that if the interest-rate rises continue unabated, the world economy will have a real problem getting its long-anticipated rebound off the ground. "This doesn't abort a recovery," says Nicholas P. Sargen, managing director of money managers Global Fixed Income Advisors. "But it sure makes one more difficult to achieve."
Of all the world's economies, the U.S. may be best able to withstand the buffeting of the bond market. Dramatic cost-cutting has made U.S. corporations more competitive than they have been in years. And massive refinancing of balance sheets has left companies able to finance ambitious capital-spending plans even if long-term interest rates continue to rise modestly. "In the great scheme of things, 6.8% is not an outrageous yield on a 30-year bond," says Joseph P. Sullivan, CEO of Chicago fertilizer maker Vigoro Corp.
Other positive signs for the U.S.: Lean inventories signal a possible production boom ahead if consumer spending holds up. Inflation remains subdued. And Fed Chairman Greenspan believes that with no evidence of wage inflation in sight, the jump in interest rates is simply a reaction to rising credit demand in a stronger-than-expected economy. No one believes the U.S. economy can sustain the 7.5% growth rate it recorded in the fourth quarter, but gross domestic product still seems set to expand by a healthy 3.6% this year, says economist Stephen S. Roach of Morgan Stanley & Co.
Europe, however, is another matter. And continuing bad news from the Old World could hurt U.S. exporters. The Mar. 2 announcement that the German money supply grew in January at more than three times the Bundesbank's 6% annual target sent a chill through European markets, which had expected continued interest-rate cuts that would speed an upturn. Guntram Palm, president of the Baden-W rttemberg central bank and a Bundesbank policy-council member, now says the Buba sees no "margin to maneuver" to bring rates down.
That could dash hopes for a recovery in Germany, where a sliding economy had seemed to stabilize in the past few weeks. Rising rates also call into question the recent signs of life in the battered French economy. Jean Louis Beffa, CEO of French glassmaker Saint Gobain, says that since last November, he has seen a reversal of the tumbling volumes and prices that had been hammering the company's glass and construction-materials operations. But now, says George Magnus, international economist at London's S.G. Warburg Group PLC, the market turmoil "has to cast something of a cloak over an economic recovery."
RIPPLE EFFECT. Japan also is facing a less rosy economic future. Although Merrill Lynch & Co. expects the Japanese economy to expand just 0.7% this year, even that is now being called into question. The rising yen, up 5% since President Clinton's failed summit with Prime Minister Morihiro Hosokawa, threatens to further crimp already weak profits and deepen the current economic downturn. Rising bond rates may make things only worse. One sign of that: The Nikkei stock average, after climbing 7% since mid-February, lost 2% of its value in just one session on Mar. 2.
If Japan is worried about higher rates, the emerging markets of Latin America and Asia are positively quaking. In Mexico, for example, rising U.S. rates are spooking the stock market and threatening to stall the Mexican economy, which expanded by only 0.4% in 1993 (page 46). Officials had been moving interest rates down--from around 16% at the close of 1993 to around 8.8% at the end of February--in hopes of stimulating the economy. But with short- and long-term rates rising north of the border, Mexico will be obliged to raise its rates to keep capital from fleeing.
When Fed Chairman Greenspan raised rates a quarter of a percentage point last month, all he wanted to do was dampen inflationary expectations in the U.S. economy. He expected a reaction from the global bond market--but did he get more than he bargained for? "All we have is sell orders out there," complains Michael R. Rosenberg, Merrill Lynch's manager of international fixed-income research. Unless the selling ceases, the global economy may begin worrying a lot more about a new downturn and a lot less about the threat of inflation.William Glasgall and Christopher Farrell in New York, with Bill Javetski in Paris, and bureau reports