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February 9, 1990
The bond market reacted well to sales of $30 billion in Treasury debt this week, and is gaining more ground this morning in spite of a disturbing inflation report.
The Producer Price Index rocketed up 1.8% in January, which in one month is more than a third of the entire 1989 index gain.
Investors have reassured themselves by noting that prices rose only .1% if the volatile food and energy components are ignored. It's a good thing nobody around here eats, heats, or drives a car; otherwise inflation might be a real problem.
Political instability has always had impact on short term movements in interest rates. However, the impact of such upsets on American markets is growing as the American economy shrinks relative to that of the whole world.
Generally, any serious foreign instability will produce a short term drop in interest rates as investors flee to the dollar as a safe haven. Word of "Gorbachev in Trouble" has consistently caused temporary bond market improvement.
On the other hand, good news for Gorbachev has tended to increase rates in the short term. This response may seem perverse. After all, good news is good news; peace in Eastern Europe should mean reduced American defense spending and fewer deficit woes.
Not necessarily so. The Soviet Union's retreat from conflict has increased the power of some of our competitors, Germany in particular. A united Germany will be a large scale borrower in world capital markets as it invests to rebuild what used to be East Germany. The safer the world looks for Germany, the less attractive is the dollar for safety and investment. The same pattern applies to Japan's safety relative to China and the Soviet Union.
"Czech Army Threatens Russian Troops," or "Victory for Soviet Hardliners," or "Baltic States Secede, Troops Sent," or "Food, Job Riots in Poland" are all opportunities for locking. Try to wait a bit when the headlines are "Warsaw Pact Disbands," or "Party Candidates Crushed in Elections."
On the economic front, the bond market is recovering from a pessimism hangover, and rates may decline a little more. However, hungover players don't like loud noises: any fresh news of a recovering economy or accelerating inflation will put us right back in the tank.
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