The outlook for the Treasury bond market remains grim and filled with uncertainty. The market hates uncertainty and probably will perform poorly until the Middle East problem is resolved. Among the culprits creating this dilemma are the escalating federal budget deficit, inflation, a good probability of a recession and an ever-weakening dollar.
The Griggs & Santow Report estimates the deficit for the current fiscal year to be $225 billion to $230 billion. For fiscal 1991, before any deficit reduction package, and including savings and loan cleanup needs, it estimates the deficit to be $270 billion to $280 billion. These figures do not include the unknown expense of the U.S. commitment in the Middle East.
These deficits have to be financed and will place a strain on the U.S. ability to finance these securities at reasonable interest rates.
It is estimated that the Treasury will have to raise $160 billion in net new money during the second half of this calendar year. Some $70 billion will have to be raised in the third quarter, with the remaining $90 billion in the last quarter. Compare this with the $86 billion of net new money raised during the second half of calendar 1989 and the $84 billion raised during the first half of 1990. This increase means that the size of the new Treasury offerings will have to be raised.
In January, the 10-year U.S. T-note returned 213 basis points more yield than the 10-year Japanese note and 76 basis points more than the German 10-year note. As of Aug. 17, the spread had narrowed to 73 basis points more yield than the Japanese note, while the German note offered 11 basis points more than the U.S. note.
With the spreads narrowing and the dollar declining, foreign investors will stay at home. These various factors, along with the worldwide demand for funds, especially in Germany, will keep U.S. rates on the high side. Only a full-blown recession is likely to move rates lower to any noticeable degree, and this is a distinct possibility.
On Tuesday, the Treasury will auction two-year notes in $5,000 minimums, and on Wednesday five-year notes in $1,000 minimums. They should return 8.33 percent and 8.78 percent, respectively.