Fiscal 1987 will be a good year for the federal budget. Not only will the deficit show a reduction for the first time since fiscal 1984, but the potential size of the reduction -- possibly $60 billion -- is noteworthy. If this potential reduction proves correct, the deficit will decline to 3.6 percent of gross national product from 5.3 percent, making it the lowest since the 4.1 percent in fiscal 1982.

The Tax Reform Act of 1986 deserves most of the credit for the favorable budget figures. An early estimate of the tax revenue increase for 1987 was $12 billion, but it now looks as if that figure will fall between $18 billion and $20 billion. A Salomon Brothers study indicates receipts will increase 10.5 percent while outlays will rise only 2.1 percent.

This good fortune has benefited the bond market, as the excess revenues in the Treasury's coffers have allowed it to reduce its borrowing needs. Using Salomon Brothers estimates, if the 1987 deficit is $160 billion, the Treasury will have to borrow $128 billion from the bond market. This compares with actual borrowings of $183.6 billion in 1985 and $189.1 billion in 1986.

Of this $128 billion borrowing, it's important to note that the Treasury will probably have paid down the Treasury bill issuance by $22.5 billion in 1987. This has at times created Treasury bill shortages in the marketplace and has also helped to maintain a very positive yield curve (three-month bill versus 30-year bond) throughout the year. The positive yield curve has aided the Treasury with its debt management program in general, and with its debt extension in particular.

The political haggling and failure of Congress to pass any meaningful deficit reduction legislation to date means that a similar deficit reduction will not be occurring in 1988. Consequently, the deficit in 1988 could be anywhere from $160 billion to $185 billion, depending on what Congress accomplishes after it returns in September.

Assuming that nothing will be done, Peter Davis of Prudential-Bache Securities Inc. in Washington goes so far as to state "that {if} no further deficit reduction action will be taken this year, fiscal policy will remain frozen until the next president assumes office in 1989." Davis believes that the fact that 1988 is an election year will rule out any progress on the budget before 1989. And that's bad for bondholders.

This means that the Treasury will be forced to borrow more heavily in the bond market during a period when many pundits are calling for higher interest rates. Salomon figures that in a best-case scenario in 1988 ($160 billion deficit) the Treasury would have to borrow $124 billion. In a worse case scenario ($185 billion deficit) they would have to borrow $149 billion in the marketplace.

The bottom line is that what Congress does concerning the budget will be extremely critical to the dollar and bond market over the next two years.

The Treasury will auction a two-year note Wednesday in minimums of $5,000 and a five-year note Thursday in minimums of $1,000. They should return 7.80 percent and 8.35 percent respectively.

James E. Lebherz has 28 years' experience in fixed-income investments