Path: bloom-picayune.mit.edu!snorkelwacker.mit.edu!news.media.mit.edu!americast.com!americast.com!usa-post Newsgroups: usa-today.bonus,americast.usa-today.bonus From: usa-post@AmeriCast.Com Organization: American Cybercasting Approved: usa-post@AmeriCast.com Subject: bonus Thu, Oct 22 1992 Date: Thu, 22 Oct 92 04:38:37 EDT Message-ID: 10-22 0000 BONUS: Clinton win wouldn't boost rates USA TODAY Update Oct. 22, 1992 Source: USA TODAY:Gannett National Information Network The bond market has been mourning the passing of Republican rule all month by driving up interest rates. On Wall Street, many worry that an era is ending: An 11-year reign of sliding interest rates and Republican presidents will soon be replaced by rising rates and a Democrat in the White House. But the bond market's grief should be short: Neither the economy nor inflation is strong enough to push rates much higher. And a Clinton administration would not mean the end of low rates. WHY WOULDN'T LOW RATES END QUICKLY UNDER CLINTON? Bill Clinton has led George Bush in the presidential polls since July. But the bond market has just started down the long road to accepting that 12 years of Republicans in the White House may end in two weeks. Since Labor Day, traders have bid yields on the 30-year Treasury bond from 7.22% to a high of 7.64% Tuesday. They worry that Clinton would increase government spending to revive the economy. That would raise the $4 trillion federal debt, which is financed with Treasury securities. WHAT ELSE ARE TRADERS AFRAID OF? They even wonder if Clinton would try the cure of last resort: turn on the government's printing presses and let inflation do the work. The bond market is terrified of inflation. But like a person dealing with the death of a loved one, the bond market is going through the three stages of grief. First came denial. All summer the market ignored that Clinton was ahead in the polls. Now it's in the anger stage, driving rates higher. Last will come acceptance, if Clinton wins. And rates should fall back. HOW IS THE MARKET REACTING? The reason the bond market probably has little to worry about is that even if Clinton turned out to be a tax-and-spend liberal, he would realize quickly that significant tax increases would wreck the economy. A big move to inflate the deficit would send interest rates soaring - and the economy deep into another recession. So the long slide in rates - a slide that began in October 1981 and has continued with few interruptions - isn't necessarily over. WHAT IS LEFT OF THE TREND? The recent rise in bond yields may not sound like much. Rates on 30-year fixed-rate mortgages, which closely track the 10-year Treasury note yield, have risen from a little below 8% in September to a little above 8% today. If rates kept rising, however, the nation's housing market, which has been improving lately, would slump again. And that could mean another fall into recession. WHAT CAUSED THE RATE DROP? Falling rates helped sustain the economy throughout the '80s. But rates started their fall from above 15% in 1981 not because Republicans had entered the White House - or because Democrats were on the way out. Bond yields fell because inflation - and the fear of inflation - had fallen. Inflation is the prime mover for bond yields. After all, a $1,000 bond that pays 8% interest has an inflation-adjusted yield of zero when inflation is 8%. So when inflation rises, bond traders demand higher yields. WHY DO BOND TRADERS REACT LIKE THAT? Bond traders are so afraid of inflation, they will bid up bond yields simply on inflation fears. That's why bond yields peaked in 1981, even though the annual rate of inflation peaked in 1979 at 13.3%. In 1981, it was 8.9%, - and falling. Nevertheless, Democrats and Republicans do have powerful, stereotypical images on Wall Street that can move markets in election years. WHAT ARE THE STEREOTYPES? Democrats, as typified by Lyndon Johnson, are supposed to raise taxes and spend freely. Republican administrations, columnist George Will once observed, are the fiscal equivalents of dental visits: not much fun, but necessary. The idealized Republican administration - at least until Ronald Reagan was elected - was supposed to limit spending, balance the budget and encourage overall fiscal prudence. But Ronald Reagan's presidency turned that notion on its ear. Tax rates plummeted. Federal spending soared. And the national debt grew larger every year. WHAT WOULD CLINTON'S EFFECT BE? No matter what his image, Clinton probably couldn't stimulate inflation - or the economy - significantly if he wanted to, says Ken Heebner, manager of CGM Mutual fund. "He's proposing a $20 billion to $30 billion package to stimulate the economy," Heebner says. "How much effect could that have on a $6 trillion economy?" Granted, a spending program that boosts employment and stimulates the economy could cause inflation to rise. But we had a rip-roaring economy much of the 1980s and the inflation rate stayed low. WHAT WOULD BENEFIT CLINTON? If Clinton were to win by a huge margin, he could possibly get a larger tax-and-spend program through Congress. But that would probably backfire, because the market would send rates soaring. And the Federal Reserve would push up short-term rates to keep inflation from flaring. "You can't overlook the fact that everyone on the Federal Reserve Board is Republican," says David Wyss, economist at DRI:McGraw-Hill. SO WHAT CAN BE EXPECTED FROM THE ECONOMY? So the economy might remain sluggish for some time. "With the exception of recent retail sales numbers, the economy just barely has its nose above water," says Ian MacKinnon, manager of bond funds for the Vanguard Group of mutual funds. WHY DO ALL SIGNS POINT TO CONTINUED LOW INFLATION? Wages, a key component of inflation, won't rise much, because so many people are out of work. Those with jobs are in no position to demand big raises when the threat of layoffs persists. Factory capacity is low. Not until factories can't keep up with demand can producers raise prices. Commodity prices have been falling steadily. Overseas interest rates have been falling, although slightly. High German short-term interest rates have lured capital from the U.S. and the rest of the world, causing a crisis in world currency markets. Wednesday, the Germans nudged a key rate lower, signaling that some pressure from high rates abroad could ease. WHAT DO MANAGERS OF BOND MUTUAL FUNDS SAY? Some say the recent rate climb has nothing at all to do with the election. "Everyone says bond yields are rising because of the prospects of a Clinton presidency, but I can't believe bond market participants are that dumb," says MacKinnon. The rise in long-term rates may be tied to the Federal Reserve not cutting short-term interest rates this month. The Fed's failure to cut signals to bond traders that the economy is strong enough not to warrant a cut. WHAT ELSE COULD CAUSE THE RISE? The rise also may be because current rates look so good. Corporations are rushing into the bond market to lock in low interest rates. The surge in supply has given the market indigestion. "It's the general belief among corporate treasurers that loans at 7.5% to 8% are a good deal," says Brad Tank, manager at the Strong Funds. So long-term interest rates shouldn't keep rising and they may begin to fall again. Bonus Editor: Kate Coughlin. (1-919-855-3491) Making copies of USA TODAY Update (Copyright, 1992) for further distribution violates federal law. This article is copyright 1992 Gannett News Service. Redistribution to other sites is not permitted except by arrangement with American Cybercasting Corporation. 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