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April 27, 1990
Though discounts didn't rise as much this week as last, the general mood of the bond market holds that Murphy was an optimist, and Chicken Little is the Polyanna of the barnyard.
Bond investors have been waiting for this morning's 1st Quarter 1990 GNP report with all the clammyhanded anticipation of Antoinette at the guillotine. It wasn't as bad as feared, showing growth of 2.1% and a modest acceleration in inflation. This GNP report will be revised twice, and the direction of the revisions will be worth watching.
Durable Goods Orders surged 6.7%, but most of the gain was a big aircraft order that will have no impact on the economy for a year or more. Despite the big overall gain, durables are still below levels of last fall.
The market has been disappointed in the Fed because inflation has not been reduced. However, the market's reassuring assumption has been that the economy was quite weak. 2.1% GNP growth is not reassuring, and the Fed may be forced to tighten any day.
The disturbing part of this scene is that the whole ugly drama may be out of the Fed's control.
There has been a demolition derby going on between the Fed and the Federal budget deficit since 1978 (though persistent deficits go back to 1961). The collisions in the last dozen years have been survivable, but the cumulative damage of issuing two trillion dollars in debt over the period is starting to tell.
A small collison occurs every time the Treasury sells budget deficit debt. The Fed cannot allow the debt to be turned into money, and is forced to maintain relatively tight monetary policy in a continuous inflation war.
Tight money tends to weaken the economy, thereby reducing tax revenues and expanding the deficit. In a debtheavy environment, a tight Fed risks misplacing what is left of the financial system. This perpetual, miserly grip distorts the economy, hurts manufacturing and real estate, but leaves services largely untouched.
Bond market investors believe that the worst deficitFed collision since 1987 (maybe 1979) is unfolding right now. The instant of impact will be the early May sale of $30 billion in debt by the Treasury.
The Treasury auction may cost the Fed a headlight and quarter panel, and the budget radiator leak will need a fix, but the last two weeks' panic is overdone. We're due for a breather no matter where we go in the long run.
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