Bonds Could Divorce a Stable Dollar This Week, Analysts Say
Aug. 30, 1992
NEW YORK (AP) _ The plunging dollar pulled bond prices lower last week - and left credit market participants wondering how long their shotgun wedding with the greenback would last.
The loose consensus among bond analysts is that unless the dollar falls out of bed again, bonds could divorce the U.S. currency as early as this week. But another rout in the currency market could spell disaster for fixed-income investors, they warn.
''Given the fact that we're close to historic lows in the dollar, I think we're probably more concerned about the dollar falling at this time,'' said Fred Leiner, bond market strategist at Continental Bank.
Bonds are ''more likely to come uncoupled from the dollar if the dollar rallies, especially because of stronger economic data,'' he said.
Plagued by concerns about the anemic U.S. economic recovery and more attractive interest rates in Germany, the dollar began a sharp selloff on Friday, Aug. 21 that continued through Tuesday of last week. The dollar fell from 1.4400 marks on Aug. 20 to 1.3900 marks last Tuesday, setting all-time lows against the German currency.
A plunging dollar is bad news for bonds for several reasons. It makes dollar-denominated bonds immediately less attractive to investors, who can get better rates abroad. Bond market participants fear that, far from lowering U.S. interest rates further, the Federal Reserve might be forced to raise them in order to attract more foreign investors to the dollar and U.S. securities.
And a lower dollar means higher prices on imports, which raises the specter of inflation, the bond market's nemesis.
Last week, the bellwether 30-year Treasury bond fell about 1 5/8 points in sympathy with the dollar, pushing the bond's yield to nearly 7.5 percent late Tuesday from about 7.3 percent the previous week. Bond prices gained modestly on Wednesday and Thursday as the dollar recovered, but eased Friday, in part because the dollar again swooned.
Before the dollar's recent drop, the bond market had been fairly independent of the U.S. currency and responded largely to economic signals.
Last week's action harkened back to the mid-1980s, when Japanese investors were leaders in the U.S. bond market. Anything, including a drop in the dollar, that might discourage them from buying bonds would send bond prices lower.
Analysts said it is just a matter of time before bonds pull away from the dollar and resume their inverse relationship.
If the dollar doesn't behave, bonds could be in for another rocky ride, analysts said. ''A lot depends on why bonds think the dollar is falling,'' said Bob Bannon, bond strategist at IDEA Inc. ''I think they could tolerate somewhat a fall in the dollar because of economic weakening.''
But if the Fed allows the dollar to fall further, Bannon said, it would signal to bond traders that the central bank does not plan to lower interest rates. The Fed would only hurt the dollar further by dropping rates.
There has been no sign that the Fed might nudge interest rates higher to support the dollar. The Fed has done little to bolster the greenback, aside from intervening in foreign exchange markets to try to push up its value.
Steve Ricchiuto, chief economist at Barclays de Zoete Wedde Government Securities Inc., said investors in short-term U.S. bonds are counting on a further easing of rates. If rates don't fall, prices of short-term Treasury securities are likely to.
An increase in rates ahead of this fall's presidential election is unlikely, analysts say. But if it happens, it could send bond prices higher by choking off any incipient growth in the economy, Ricchiuto said.