Inflation

Even though higher quality long bonds stalled in October, short rates continued to decline in anticipation of yet another cut in the discount rate. Once again it has been demonstrated that long and short rates do not have to move together.

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The bond market parted company with the stock market in September, extending its July-August advance while the stock market backed and filled. Only junk bonds were a mixed bag, as all other fixed income sectors moved up in tandem.

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August was a good month for bonds. Long treasuries recorded net gains of three points or more, with yields falling 30 basis points. T-bonds are now back up to where we sold them in January and February 1991.

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In July, the bond market gained back about what it had lost in June. After a quick sell off following Independence Day, prices moved erratically higher for the remainder of the month.

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The first half of June was almost all downhill for the bond market. The remainder of the month was spent moving sideways, with a blast upward on the last day of the month. It was a mini flee to quality.

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In early May, the bond market was hit hard by a post Treasury financing sell off. It spent the rest of the month recovering.

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The concept of a “real” rate of interest is widely held, but it does not appear to be a natural law. It is not a truism that has prevailed forever. Like many investment concepts and theories, sometimes it works and sometimes it doesn’t.

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For the month of April, higher quality long bonds turned in small fractional gains. The economic tea leaves were mixed, inflation numbers were good, the dollar held up and short term rates came down. However, a big pick up in new fixed income offerings seemed to satisfy investor demand.

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In March, the fixed income markets were a mixed bag. Short term rates fell 25 basis points and 90 day bills ended the month well below 6% (5.74%). Junk bonds extended their sharp February rally. Outside of short term rates and junk bonds, the fixed income markets recorded little net change in March.

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The bond market continued to advance in early February. It peaked however on February 8th, the day after the Treasury completed its financing. In the week following, T-bonds held in a narrow range, but began losing ground in the last half of the month. In the final days of February and on the first trading day of March, the decline picked up momentum.

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War, recession, falling oil prices and other good inflation news combined to support the U.S. fixed income markets in January.

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In November, recession evidence continued to build. War fears started to fade. November 17 came and went, and the Bush hawk began his molt. The dollar stabilized, at least momentarily. Inflation fears faded, as oil prices traded down. In this environment, the bond market marched steadily upward all month.

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Crude prices fell 11% in October and almost all other commodities moved lower, easing recent inflation fears. The economic numbers mostly continued to say recession, with the exception of the new GNP number. However, very few believe the accuracy of the number.

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In examining various consumer and producer price measures going back for as long as 1000 years, it was found that prices have risen about 60% of the time and fallen about 40% of the time in the Western world.

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The recent improvement in the bond market is probably not the result of the politicians’ weak kneed program to deal with the deficit. Rather, it more likely stems from the lack of bad news from the Middle East and growing evidence that the economy is in a recession.

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As things heated up in the desert, the bond market swooned. Late in August, Middle East tensions eased somewhat, with the dollar and the bond market staging a rally, trimming the losses for the month. Nevertheless, bond market damage in August was still severe.

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Iraq may have been responsible for knocking a fast 100 points off the market in early August, but the stock market had already rolled over. The Leuthold Group’s Major Trend Index deteriorated significantly with the July 27th calculation. This was before Hussein made his move.

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All things considered, the bond market held up well in July. And even though the dollar index slid about 4%, there was little progress on the deficit front and inflation fears rose with oil prices. These bond market negatives were offset by increasing evidence of a recession in the works.

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George Bush turned the bond market around during the last week in June, mentioning that “tax revenue increases” are needed. Long bonds rejoiced by moving up about two points in the last four trading days of June.

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The bond market surged upward in the first part of May, and then consolidated those gains for the remainder of the month. Bonds have again blasted upward here on the first day of June.

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