Capital Markets

Look Both Ways: Irrational Gloom?

One economist says that the current rush toward investment in safe-haven Treasury securities may not have a rational basis.
Ed ZwirnFebruary 14, 2005

Just as Federal Reserve Chairman Alan Greenspan warned of the impending collapse of the equity bubble of the late 1990s, one economist now says that the current rush toward investment in safe-haven Treasury securities may not have a rational basis.

As U.S. equities continuing to exhibit a poor showing, both corporate treasurers in the United States and central bankers abroad are continuing their recent rush toward investment in what is normally considered a “risk-free” realm: debt issued by Uncle Sam himself. And despite an ever-increasing supply of government debt, this mini-trend shows no signs of abating. This past week’s dip in 10-year Treasury yields to below 4 percent — for the first time since last March 2004 — seems to indicate that these investors have serious concerns about the health of the U.S. economy, according to conventional wisdom.

Those concerns — if indeed they are driving the Treasury rally — are misplaced, maintains John Lonski of Moody’s Investors Service. “The Federal Reserve was helpless to thwart the inflating of the late-1990s’ equity price bubble” that prompted Greenspan’s famous remarks, Lonski wrote last week. “Similarly, the Fed may be at a loss when attempting to avert a Treasury bond price bubble, whose latest swelling might yet trigger another round of aggressive bidding for residential real estate.”

Speaking to, Lonski said that the current situation was comparable to the late 1970s, when the Iranian hostage crisis and an oil embargo combined to produce “negative real 10-year Treasury yields,” in which the government paper fetched 0.3 percent less than the core rate of inflation (core CPI). The current “real yield,” he maintains, is about 1.9 percent. By year-end, he predicts, the nominal 10-year Treasury yield will be at “5 percent or higher.” Since residential mortgages are priced in relation to this benchmark, anything approaching 7 percent would be enough to put a crimp in the current bull market for real estate, he adds.

Giving the lie to the bearishness implied by the Treasury rally, on the other hand, is the current narrowing of spreads for both investment-grade and high-yield corporate bonds, says Lonski. The typical high-yield spread of about 313 basis points over the 10-year Treasury is about the same as the 1997 level.

“There’s a lot of liquidity out there,” says Lonski, but there’s also “a high level of caution by executives who remember the collapse of the high-tech market.” Adds Lonski, “Sarbanes-Oxley is diverting management energy,” a situation which should turn around “once businesses have fully adjusted” to the law’s provisions.

Looking ahead this week:

• Tomorrow’s retail sales update for January from the Commerce Department should show “a weak number,” but not as weak if you back out “auto dealership” sales, says Lonski. The consensus, compiled by, is for a 0.4 percent drop in the overall number, compared with a rise of 1.2 percent for December. Excluding autos, expect to see a 0.4 percent rise, compared with 0.3 percent. “It’s going to be impossible to duplicate 2004’s overall 8 percent rise in core retail sales,” insists Lonski.

• Wednesday’s housing numbers from Commerce are also expected to be similarly unspectacular. Look for 1.93 million housing starts for January, down from 2.004 million the prior month. Building permits are expected to come it at about 2 million, compared with 2.032 million a month earlier.

• Also on Wednesday, the Federal Reserve is expected to report that industrial production rose 0.3 percent in January, down from 0.8 percent in December, and to peg capacity utilization at 79.3 percent, compared with 79.2 percent the prior month.

• Thursday’s Conference Board report is expected to show leading economic indicators falling 0.2 percent last month, compared with an increase of 0.2 percent in December.

• Anybody remember worrying about inflation? Friday’s producer price index report from the Labor Department is expected to show a 0.3 percent rise for January, following a drop of 0.7 percent in December. But excluding energy, the number is expected to show much less volatility, with the core increase pegged at 0.2 percent last month, up from 0.1 percent for December.

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