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September 22, 1995
Two weeks of quiet flirtation with seven percent mortgages have come to an abrupt conclusion. Rates didn't make it far into the sevens, but any "seven" has a nice ring to it. We are back near 8.125% this morning, and may try 8.50% before this move is over.
A reversal in the dollar rally is the immediate cause of the interest rate rise, as a weak dollar tends to take the bond market along for the crash ride. Though a record rise in the trade deficit ($11.50 billion in July) is the usual suspect, there is funny business going on in the currency markets.
Trade deficits can be a sign of inflationary over-consumption in America, but our imports are lower now than early in the year. The current deficit has more to do with a foreign policy failure than with economics. Two thirds of our deficit can be traced to two countries: Japan (same, old game), and China (trying Japan's game).
However, trade does have to do with the funny business. Last spring, when the yen hit 79 to dollar, Japan's economic woes were going to be compounded by an export disaster. Japan set out to weaken the yen.
By early this week, the yen had fallen to 104/dollar. How did Japan go about weakening the yen? Spend 'em! Though the spending had the desired effect on the yen, it has also had some side-effects.
The first has been to help American interest rates. In the first four months of 1995, Japanese investors bought $9 billion worth of foreign bonds; from May through July, they bought $48.7 billion. If you're talking "foreign" bonds, you're talking US Treasuries, and if anybody throws that kind of money at our bond market, it will do well.
Another side effect is typical of all market manipulations. What happens when you stop? Or overshoot? While Japan's intervention has gotten the desired result, markets are going haywire trying to adjust. We should expect more interest rate volatility in the next couple of months while traders try to locate the real economy and the Fed's intentions.
At the height of Thursday's dollar, bond, and stock market distress, Mr. Gingrich decided to fire a salvo of shut-down-the-government budget bombast. As everyone will soon be aware, Mr. Gingrich and others demand that their budget be passed in October or there will be no budget, and no money at all. On Thursday, he told a convention of bond traders, "I don't care what the price is. I don't care if we have no executive offices, no bonds for 60 days."
A roomful of traders could sleep soundly through any politician's blather, even a Gingrich one-man shouting contest. But mention the word "bonds"Š bonds?Š BONDS?Š MY BONDS?!Š and a bad day got worse.
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