For Bond Traders, It's The Best Of TimesJeffrey M. Laderman and Christopher Farrell
At 4:30 a.m., the morning after President Bill Clinton outlined his tax-and-slash economic plan, Jerry Harris rushed to his Montgomery (Ala.) office to gear up for the bond market's opening. Harris manages $500 million in debt for First Alabama Bank, and he knew big-time action was in the offing. How big, he couldn't have guessed. Bond prices soared over the next five trading days, sending interest rates plunging to 6.83% on Feb. 23, before backing up slightly to 6.89% the next day. "I have to give Bill Clinton a lot of credit for focusing on the right issue," says Harris. "Deficit reduction."
True, Clinton's economic plan--featuring steep tax increases and moderate spending cuts--is drawing mixed reviews from business. Executives uniformly applaud the attempt at deficit taming, although many reject the new energy and income taxes Clinton proposes to do the job.
But to bond-market investors, who collectively are more powerful than the Federal Reserve in determining long-term interest rates, the proposal seems the stuff of dreams. Clintonomics, says this crowd, should temper the economy's comeback and keep inflation low. A huge tax hike "in a weak recovery means the recovery will falter," says David Glen, portfolio manager of the AARP GNMA & U. S. Treasury Fund.
Although not a recipe for another recession, economists agree that the Clinton plan certainly will slow economic growth from 1994 to 1997. Gross domestic product should increase by 3.3% this year, spurred in part by the Administration's $30 billion short-term economic stimulus package, says Mark Zandi, economist at Regional Financial Associates Inc. After that, the impact of tax hikes and spending cuts could slash almost a full percentage point off growth by 1995.
Unless, that is, the bond-market rally keeps going. Then, a lucky Bill Clinton has hit the economic jackpot: a lower deficit and stronger economy. Every percentage-point decline in long-term interest rates adds some $100 billion to the economy over two years, estimates David Wyss, an economist at DRI/McGraw-Hill.
MORE ORDERS. That's because lower interest rates lift exports by keeping the dollar's value competitive and allow homeowners and businesses to refinance loans at cheaper rates. Lower rates also drive down the cost of new investment, especially when coupled with the Administration's Investment Tax Credit for new equipment and machinery. Spectrian Inc., a $35 million maker of high-tech telecommunications equipment, does not expect much of a direct benefit from the ITC. But Chief Executive Woody Rea says the credit "will help a lot of our customers who build the infrastructure for wireless communications," which means more orders for Spectrian.
Not that such matters of commerce concern bond folks much: For them, the self-fueling rally is a money-making opportunity. Every new high in bond prices--and corresponding low in yields--brings in more cash. Mutual funds, pension funds, and insurance companies eagerly bid for bonds. Investors holding mortgage-backed securities and fearing that another wave of refinancing would rob them of their yields, dumped mortgage securities and sought Treasuries, too. Bond dealers, not expecting a boom with yields already at such low levels, had little supply on hand and scrambled to buy product. Investors were especially heartened after Federal Reserve Chairman Alan Greenspan told Congress on Feb. 19 that the Clinton plan was not inflationary.
In all, say traders at major investment banks, government-bond business increased anywhere from 25% to nearly 100% over the past two weeks. "It's not hysteria," says Denise M. Cumby, a Salomon Brothers Inc. managing director in charge of government products. "But there are extremely large flows of cash coming into the market." Many traders believe the market is establishing an unprecedented new range for 30-year bond yields of 6.5% to 7%.
Low as they are, interest rates won't remove everyone's doubts about the economy. That's why stocks haven't joined in the bond market's fun: Instead, shares ricocheted nervously in the days following Clinton's address. Equity investors, like many corporate executives, fear that higher taxes will hit consumers and businesses hard. "The tax increases hit the consumer right between the eyes as the consumer is just getting up off the mat," says Stephen S. Roach, economist at Morgan Stanley & Co.
Nor will the program do much to spur job growth, despite the Clinton Administration's belief that its policies will create some 500,000 jobs by the end of 1994. "The cost of hiring has increased," says Charles Clough, chief investment strategist at Merrill Lynch & Co., "and the incentive to hire has decreased."
Take the mining industry. Clinton's proposed 12.5% royalty on mining production on government lands "will dry up a lot of jobs on the exploration side," complains Stanley Dempsey, chief executive of Royal Gold Inc., a Denver-based gold-exploration company. Miners predict that the royalty will make new mines in the U. S. uneconomic and cut prospecting, as producers turn to foreign countries.
JOB LOSSES. Then there are the proposed military cutbacks. Trimming the Pentagon's budget will cost at least 1 million jobs by 1996 in defense industries. And any plans to contain health-care costs could take a toll on job creation. The health-care industry produced some 512,000 jobs during the first 22 months of the current economic expansion; without these new jobs, payroll employment in that time would be down by 14,000, according to Edward E. Yardeni, chief economist at C. J. Lawrence Inc. And Clinton's activist agenda, from family leave to health-care reform, is making workers more and more expensive. In other words, it's cheaper to purchase machinery.
Still, until a final economic package works its way through two houses of Congress and thousands of lobbyists, its impact will be subject to continuous debate by business people, economists, and investors. But bond investors, never ones to equivocate, have spoken early and decidedly: They like the plan. And this one important, if exclusive, constituency could be the one to tip politics in favor of Clintonomics.