Pause in the Bond Boom

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Bond buyers are demanding the high rates because they see so many things happening that could reignite inflation They fear, for example, that Washington's free-spending politicians will do litle to prevent a new price surge, leaving he fight once again to the U.S. Federal Reserve, which has carried the burden almost alone since 1979.

In particular, investors saw the congressional lameduck session just ended as yet more proof that the Government remains hopelessly incapable of reducing the nation's ever swelling budget deficit. Last week alone the Treasury issued $26 billion of bills and notes to help feed the Government's craving for cash, and the needs will grow as the federal deficit heads to a record $165 billion this fiscal year. One Treasury aide describes the borrowing outlook for early 1983 this way: "You can think of it as $5 billion a week, $1 billion a day or $125 million an hour."

Though not necessarily inflationary during a period of extreme economic weakness such as now prevails, the record Government deficits will prove hugely disruptive once the economy begins to recover. That is because the borrowings needed to cover them would tend to "crowd out" private corporations from the nation's credit markets, forcing interest rates to levels that would either choke off growth altogether or else compel the Federal Reserve to expand the money supply so rapidly as to rekindle inflation.

During the recovery from the last serious postwar recession of 1973-75, economic growth eventually gave way, beginning in early 1978, to a rebirth of high inflation. Then the Federal Reserve began to tighten up on credit to cool off the economy and bring inflation to heel. Yet making money scarce automatically makes it more costly, thus pushing interest rates up and sending bond prices skidding.

Having learned from bitter experience what can happen to their investments in a recovering economy, bondholders in recent weeks have grown wary and started cashing in on their spectacular 1982 profits while the economy is still weak. The selling has put further downward pressure on prices, which have slipped by an average of about 5% from their rally peaks. That in turn has helped hold interest high, and made businessmen and investors start to wonder if the cost of money will fall much farther under even the most favorable circumstances.

Yet in spite of the uncertainty, a long list of investment analysts and economists argue that interest rates are bound to keep falling in 1983 no matter what the economy does, making bonds still one of the best buys in all of finance. Not only are rates high, but inflation, for now at least, is in full retreat.

Further evidence of progress in the inflation fight came last week when the U.S. Labor Department reported that consumer prices rose during November by a mere 0.1%. As a result, inflation for all of 1982 now looks likely to remain under 5%, the lowest level in six years. Says David Levine, economic analyst for the investment firm of Sanford C. Bernstein & Co.: "The long-term outlook for bonds is bright indeed. The vast amount of slack in the economy will ensure that inflation will continue to decline even after the economy starts to recover."