With the stock market booming, the average investor is unaware of the potential hyper bull market developing in Treasury bonds. Low interest rates mean prosperity for the stock investor, but deflationary pressures could subvert this relationship, resulting in higher T-bond prices and slackening stock prices. This drop in interest rates will be fueled by three major fundamentals: a new economic structure, Asian economic woes and evolving computer problems with the year 2000.
Current real rates are too high historically according to the core consumer price index (CPI) growth of 2.3%. The last time the core CPI grew this slowly was the mid-1960s when bond rates were 5%. Now 30-year yields are close to 5.70%. Current rates may be too high because the market has had difficulty comprehending structural changes in our economy. Low inflation coupled with unparalleled growth can be explained by a new economic model. Some components of the new economic structure include increased global competition (in both goods and wages), the technological revolution, demographics in the work force and U.S. corporate streamlining. The result is high productivity with virtually full employment and little inflation. These are a few reasons why bond yields should be at 5% today.
Has a decade of inflation fears misdirected the Federal Reserve Board away from the possibility of deflation? The Fed had similar fears during the 1930s economic crisis when many economists worried about the hyperinflationary times of the 1920s in Europe. Is the Fed of the 1990s making the same mistake as the Fed of the 1930s?
The second fundamental factor is the economic crisis in Japan and Asia. In October 1997, the world saw the first effects of the Asian contagion. Stock markets plummeted and bond prices soared as investors sought a safe haven for their money. The safe haven for the last decade has been U.S. Treasuries. After the International Monetary Fund bailout, the situation stabilized, and Western economies awaited a fallout. Earnings for _ some multi-national corporations slipped, but no major problems occurred.
But cracks are appearing. First quarter imports rose at an 11.6% annualized rate, while exports fell at a 3.4% rate, according to the U.S. Commerce Department. In dollar terms this is the largest drop in U.S. exports on record. These numbers are disturbing because of the inability of Asian countries to import goods and the propensity to export more to raise capital. The result is cheaper goods (deflation) and lower interest rates. The problem in Asia started in Korea, Hong Kong, Indonesia and Thailand. Japan, the second largest economy in the world, …