Bear Market Horizon
Jude Wanniski
April 8, 1996


The recent sharp narrowing of the yield spread on bonds -- with the 2-year climbing faster than the 30-year -- is only one piece of our assessment of a bear market interlude, but an important one. Over the same track of time since early February, the 30-year has climbed to 6.9% from 6%, while the 2-year has climbed to 6.15% today from 4.8%. When the immediate future begins to look more risky than the distant future to Wall Street, it is always a good sign that business folk on Main Street will be more hesitant too, pulling in their horns, as the saying goes. In the business trenches, it may appear the problems are being caused by tight money policies by the Federal Reserve -- keeping interest rates higher than they should be. Yet the actual policies of the Fed this year have been close to optimal, at least given the limitations of operating in a day-to-day greenback world. It has been the rhetoric that emanates from Greenspan & Co. which has been dismal, unnecessarily adding to the risks that bear upon business activity. By threatening to raise interest rates to shut off undesirable economic growth, the Fed thereby causes market rates to rise. The pounding the stock market is taking today would not be occurring if the Fed had not trained the market to worry about too many people going to work -- which was the essence of Friday’s positive report on job creation.

Of course, Chairman Greenspan will not admit responsibility for causing bond yields to soar or the stock market to plunge, as they did in reaction to the Good Friday report. Were he to testify before the Congress on Wall Street’s anxieties, he would no doubt express dismay at the failure of Congress to reach agreement with the administration on a balanced-budget plan. The fact that the nominal budget deficit now is almost half what it was in the summer of 1993, when the long bond was at 6% ($140 billion now versus $260 billion then), would undercut such argumentation. The political gridlock on the budget of course has taken tax policy out of action as a spur to either the equity or fixed-income markets. The interlude in presidential politics also adds to the sense of gridlock. Bill Clinton and Bob Dole have won their party’s nominations so early that they must spend the next five months jockeying for position at the starting gate, as opposed to debating a national agenda in a genuine race. 

As a result, the markets must fix on the Fed alone. They will increasingly move in unison, again “coupled” as they are today, moving south simultaneously, instead of “decoupled” and diverging, as they were in the first quarter of the year. What’s bad for bonds will be bad for stocks as the two markets now have coincident economic horizons. The sharp climb in the 2-year bond strongly suggests the market is building up an increased risk that the next Fed move will be to a higher funds rate. The climb in the 30-year yield suggests the market is betting the next gold price move will be up, not down. Since the summer of 1993, when the federal budget deficit was almost double where it is today, the gold price as a harbinger of future monetary inflation has risen by 15% to $395. In our bullish moods, we could imagine scenarios in which Greenspan could retrace the gold path to $350, accompanied by a boom in both stocks and bonds. For the next several months, it is hard to imagine such scenarios. They require the prospect of increased tax rewards to economic risk-taking, to give the Fed political elbow room to permit a mild monetary deflation. It now is much easier to see Greenspan for the next few months presiding over the kind of bearish marketplace we see today, with no good options.