Bond market rally may be played out Climbing rates unsettles Dow


NEW YORK -- Spooked by a strengthening economy and weakened by profit-taking, the bond market fell again yesterday, indicating that the market's record-setting rally may be over.

The yield, or amount of return that an investor can expect, of the benchmark 30-year government long bond ended yesterday's trading session at 6.21 after hitting 6.24 during the day. Just three weeks ago, the bond had been at a record low of 5.75.

Normally the stuff of Wall Street insiders, the bond market has attracted national attention this year as President Clinton often cited it as proof that his economic policies are working.

Lower rates have also helped the stock market to record highs. But with rates now climbing, the market has been unsettled this week. The Dow Jones industrial average rose 18.45, to 3643.43, yesterday, but the index was off 37.16 points for the week.

For millions of homeowners, the rally had provided low interest rates that had allowed them to refinance their mortgages. The market's new shift could signal an end to that: Fixed-rate 30-year mortgages averaged 7.11 percent this week, up from last week's 6.86 percent. For a $100,000 loan, that works out to about $50 more a month in interest payments.

The bond market's shift came as traders woke up to the fact that recent economic reports have been largely positive. While good news to most people, bond traders associate a strong economy with increasing inflation, which is bad news for bonds because it eats into their long-term value. To compensate for this risk of higher inflation, bond buyers demand higher interest rates, so rates have been rising as the economy has perked up.

"The bond market abruptly noticed that the economy is gaining momentum. It's hedging against inflation," said Paul Boltz, chief economist at T. Rowe Price & Associates Inc.

"The economy had been held back because of natural catastrophes, like the floods, and uncertainty surrounding the new tax bill and health care reform. Now that these are past us, the economy is snapping back," said Roger W. Marshall of Riggs Investment Management Corp.

Mr. Clinton said it was natural that, as the economy picks up, interest rates will rise slightly. At a press conference yesterday in Washington, he said he was "not alarmed by it."

"What's happening is the economy is getting much healthier. It's hard to keep interest rates at a 25- or 30-year low" with an improving economy, Mr. Clinton said.

Economists were unsure, however, exactly how low interest rates would stay. Some said the yield on the long bond could easily rise to 6.5 percent until the New Year, when the economy should show more clearly whether it is truly rebounding -- and bringing inflation with it -- or just in one of its periodic blips upward.

Another reason for the bond market's collapse has been profit taking, said David Resler, chief economist with Nomura Securities. Many bond traders have seen their portfolios increase 20 percent this year. Rather than risk their money in the market any longer, they are withdrawing until the end of the year, he said.

"This way, when the year is over they can show good results to their clients. Otherwise they might risk a further decline in the bond market and then their results wouldn't look so hot," Mr. Resler said.

A more technical reason for the bond market's woes has to do with the government's financing of the national debt, said Wayne Wong, managing director of Marinvest Inc. As the government has issued more short-term debt and less of the standard 30-year bonds, traders have begun to trade the 30-year long bond like a commodity -- buying and selling it based on its availability.

This led to more speculative trading of the bonds than usual, Mr. Wong said, causing the bond to be bid up until mid-October. Then, when the herd changed direction, the price fell dramatically.

"This doesn't mean that inflation has shot up to the moon," Mr. Wong said. "It means that people are a little spooked but will probably calm down soon."

The markets could take a different view of the economy later this year or in early January when several factors kick in to slow economic growth, and the market's fear of inflation. Taxes will increase then, defense expenditures will probably continue to fall, trade agreements might not be worked out and exports could continue sinking, Mr. Wong said, leading the market to take a less optimistic view of the economy.

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