Interest rates on the 30-year Treasury bond will fall below the 6% mark in early 1998 as the budget deficit continues to shrink, inflation remains low, and supply of the long bond also diminishes, said Smith Barney economists Mitchell J. Held, Douglas Schindewolf, and Bill Sharp.
Increases in the consumer price index have remained under control, with the psychological impact of low inflation creating an environment where price-setters are reluctant to raise prices for fear of losing market share, thereby keeping inflation down, they said.
If government spending increases continue to be outpaced by growth in tax receipts at their current 4% to 9% ratio, the budget will be at a $50 billion surplus, the economists calculated.
Inflation
Daiwa Securities America Inc.
Michael Moran
Moderate third-quarter growth and the absence of strong hints of inflation will hold the Federal Open Market Committee back from raising interest rates at its Sept. 30 meeting, predicts Michael Moran, chief economist with Daiwa Securities.
The producer price index has declined for seven straight months and increases in consumer prices have remained very modest, Moran noted.
Moderate economic growth in the second half of 1997 is suggested by the fact that while payrolls rose sharply in July and the workforce grew by 300,000 workers, companies cut a few hours from the average workweek, keeping output down, he said.
Tax-Backed Bonds
Merrill Lynch & Co.
John Hallacy
Credit-based trading has become more difficult as more than 50% of new municipal debt is insured, credit spreads continue to tighten, and natural triple-A ratings become more plentiful, according to John Hallacy, managing director of municipal bond research at Merrill Lynch.
There are questions about how rich tax-backed bonds can get before resistance develops and dealers are put in the position of holding more inventory, Hallacy said.
While strong financial numbers have led to most of the upgrades to triple-A status, others may have been spurred in part by the influence of bond insurance on the entire market, he said.
Retail Demand
Smith Barney Inc.
George Friedlander and Bart Mosley
Considering the vast supply that has entered the bond market, municipals have fared well during the market's pullback, said Smith Barney analysts George Friedlander and Bart Mosley.
The 25 basis-point increase in yields recaptured many retail buyers, as those who thought they had missed the rally, and also those who saw yields hit their yield targets - for example 5.50% for 30 years - opted to buy, according to the analysts.
The municipal market should settle into a trading range until Labor Day passes, unless wild fluctuations in the Treasury market carry tax-free bonds with them, they said.
