Last year, the Clinton Administration made a deal with the bond market. It offered $500 billion in deficit cuts through 1997 in exchange for lower long-term interest rates and a better economy. Now comes the powerful lesson: What the bond market giveth, the bond market taketh away.
Despite mounting evidence that the economy is slowing down and inflation is under control, the bond market has pushed the yield on the benchmark 30-year Treasury bond to slightly more than 8% for the first time since May, 1992. The yield has risen from the record low of 5.78%, which hit about this time last year, and it's well above where it was before the Clinton economic team began its budget-cutting efforts.
Back then, the White House argued that each tenth-of-a-point decline in the yield was like adding $10 billion in stimulus to the economy. Now, it's the bond market's revenge. The rate rise has drained away all of the stimulus last year's rate drop had added--and then some. And the economy will feel the negative effects in 1995.
The trouble is, bond players still don't believe that long-term rates have risen high enough to slow the economy and kill off the inflationary pressures they believe are now building. Until that happens, long rates will continue to rise.
MEANWHILE, THE DATA should be allaying the bond market's worst fears. But with its blinders firmly in place, the market chose to ignore recent evidence on modest factory orders, falling consumer confidence, and slowing employment costs (charts).
Instead, it focused on a 4.4% rise in September housing starts as a sign that the economy was overheating. It was a knee-jerk reaction to that number that pushed the bond yield above 8%. True, the increase was larger than expected, but there is less strength than first meets the eye. Housing starts in the key single-family sector, up 6.1% in September, are below their March level and well below their December peak, as higher mortgage rates whittle away affordability.
Much of this year's housing activity has been in apartment buildings. But that's more the result of the Administration's restoration of tax breaks for low-income housing rather than a reflection of booming private-sector demand for co-ops and condos.
Builders surveys are increasingly downbeat about future demand, and new mortgage applications to buy a home in mid-October were below their September level, which was lower than in August. Sales of existing single-family homes managed a 1% gain in September, to an annual rate of 3.97 million, but that's still down from earlier this year. Overall activity should look weaker in coming months.
In addition, factory activity, while still on the rise, is losing steam compared with its pace earlier this year. Orders for durable goods were essentially unchanged in September, posting a scant 0.1% gain. That followed a 6.4% surge in August, fueled by a rise in auto-industry bookings.
But even excluding the volatile transportation sector, third-quarter bookings grew at the slowest rate in more than a year. Slower order growth is hardly a sign that industry is barreling down the road toward capacity limits. That road, according to the bond market's map, ends at higher inflation.
THE BOND MARKET'S worries about an overly robust economy don't jibe with the views of many consumers. On the contrary, consumer confidence fell in October for the fourth consecutive month. The Conference Board's index slipped two points, to 87.6. Although households' assessments of prevailing conditions have held up in recent months, their expectations for the future economic climate have been falling off for the past six months.
Uncertain employment conditions remain foremost on consumers' minds. An increasing number of households reported that jobs were "hard to get" in October, and the number of consumers who fear fewer jobs in coming months has been trending higher since June.
Those fears, combined with higher interest rates, may already be curtailing some spending. The Conference Board also reported that buying plans were down sharply in October. Plans to buy a new home fell for the second consecutive month, as did intentions to purchase major appliances. Plans to buy a new automobile dropped for the third straight month. Indeed, the Johnson Redbook survey of department and chain store sales through mid-October shows receipts running about even with September.
If one number should have allayed the bond market's inflation worries, it was the Labor Dept.'s report on labor costs in the third quarter. Its employment cost index of wages and benefits for civilian workers rose a modest 0.7% last quarter, and the increase from a year ago was a tame 3.2%, matching the annual pace in the two previous quarters. Those rates are the smallest since Labor began collecting the data back in 1981.
The numbers show that, despite the more than 2 million jobs created this year, labor costs have not accelerated. Businesses' determination to wring more output from existing labor and plant capacity has kept labor costs down. And without faster rising wages and benefits, the wage-price spiral cannot get in gear.
Wages and salaries in private industry, about three-fourths of overall compensation, were up 2.9% from a year ago, little changed from their annual pace of the past two years. And benefits, up 4% from last year, remain in a declining trend.
THE SLOWDOWN in benefits costs has been especially sharp among blue-collar workers in the goods-producing industries. That makes sense. Employment there, particularly in manufacturing, has barely grown this year, and many factories are continuing to employ part-time workers, to whom they are not required to pay benefits.
And despite this year's increased activity by organized labor, pressure from unions is almost nonexistent. Third-quarter labor contracts called for pay gains averaging 0.9% in the first year and 1.9% per year for the life of the contract. Those increases are below inflation and also less than the first-year hike of 2.6% and the full contract's 2.8% increase agreed to the last time the same parties bargained. The new contracts cover 348,000 workers.
Right now, though, the bond market is not interested in this kind of low-inflation logic. It's also not interested in the Administration's recent crowing about the decline in the budget deficit from $254.7 billion in fiscal 1993 to $203 billion in 1994, and to a White House-projected $167 billion in 1995. That's old news to bond players.
What the bond market wants is a solid reason to change its bearish mindset. But until it is convinced, the market will keep pushing rates higher to satisfy its urge for a slower, noninflationary economy. So once again, Clinton--and the economy--find themselves at the mercy of the bond market. And this time, the market is not in the mood to deal.