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August 1, 1997
Irrational exuberance in the bond market came to an end with a bang today.
Several bangs, actually. Non-farm payrolls jumped by 316,000 new jobs in July, 60% over the forecast, which took unemployment down to 4.8% versus 5.0% estimated. The purchasing managers' index jumped 3% in a single month, up to 58.6%, and 58%-plus is one of the Fed's many danger zones.
"Zero and zero" mortgages are trading around 7.625% this morning, and rising, despite Freddie Mac's latest nitwit announcement: "7.36%" based on two points and a week-old survey.
The sources of the exuberance in the bond market are clear: thirty-year lows in all measures of inflation, a slightly cooler economy in the second quarter of the year (not the third!), a dollar pushed to record highs by Europeans who've lost faith in the ecu, andŠ above allŠ no bonds for sale.
In a reprise of Monty Python's John Cleese as the proprietor of a cheese shop with no cheese (Cotswold? "Sorry, fresh out." Cheddar? "Perhaps next week." Brie? "Christmas only." Roquefort? "Missed the delivery."), we have a bond market with no bonds.
Having nothing whatever to do with the budget deal, the budget has almost balanced itself, entirely with higher tax revenue. Income tax receipts are running 13% ahead of last year, and a projected $120 billion 1997 deficit is now down to $40 billion. From July through September, the Treasury was supposed to borrow $40 billion in new cash; instead, the Treasury needs only $10 billion.
Meanwhile, the Treasury is paying roughly $75 billion in interest every 90 days. Most of this money doesn't get spent, it gets reinvested somewhere, usually in more Treasurys. This year for the first time in 30 years, the Treasury is borrowing less money than it pays in interest, and investors are scrambling to find something to buy.
March, as Fed Tightens Yesterday Change
Fed funds 5.25% 5.50 + .25
90-day T-bills 5.38 5.23 - .15
1-year T-bills 5.80 5.43 - .37
30-year T-bonds 6.72 6.29(!) - .43
We can observe, chart, and describe an irrational episode, but it's still irrational. For yesterday's bond yield -- perhaps the point of maximum exuberance -- to be rational, you have to believe the Fed is about to ease, which is not a rational belief.
"A ten-year note? Sorry, all out for the summer. Try us next year, won't you?"
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