Greenspan's Rates of Wrath

The Fed jacks up borrowing costs, but the move is too much for Main Street and not enough for Wall Street

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I used to think if there was reincarnation, I wanted to come back as the President or the Pope or a .400 baseball hitter. But now I want to come back as the bond market. You can intimidate everyone.

--James Carville, Clinton campaign strategist

But even bullies get the blues. In fact, last week may prove that the redoubtable bond market suffers from a permanent case of existential fretting. From his temple-like headquarters in Washington, Federal Reserve Chairman Alan Greenspan offered up to traders what they had been counting on: he raised short-term interest rates on Tuesday by the largest amount since 1981. His goal was to restrain the economy and forestall inflation. If traders are convinced that inflation looms, they might dump bonds and thereby drive up the cost of the long-term loans that have financed the business recovery.

But no sooner had the Fed acted than bond investors began to worry that the 0.75% rate hike might not be enough to keep inflation at bay. "There's more to do, so what's the point in being a hero and buying bonds at this rate when it still has a way to go," said David Glen, 37, the manager of $6.5 billion in bond funds for Scudder, Stevens & Clark. So after a brief period of euphoria, the bond market tumbled.

This vote of no confidence gave the bond market the aspect of a fierce pagan idol that can never be appeased. No sooner does the market receive one form of tribute than it finds fresh problems to worry about. Among other things, investors saw a new threat of inflation in promises by House Speakerin-waiting Newt Gingrich and other Republicans to cut taxes next year without any credible program for restoring lost revenues. "Tax cuts are not always good for the bond market,"said Joseph Carballeira, the head of U.S government- securities trading at Smith Barney. "Initially, there was a sense of optimism when the Republicans won. But now there is the sense that fiscal discipline may be over." Said Hugh Johnson, chief investment strategist for First Albany: "This has become a nagging fear that bond traders have in the back of their heads. They might not discuss it much, but the fear is there."

Greenspan seemed to be striking out on two fronts: he was receiving little credit from the bond market for jacking up interest rates for the sixth time this year, and he was unintentionally deepening an old fault line in the American economy. "Never before has there been such a huge gap in perception between what is going on in the real economy and what the financial markets think is going on," says Robert Hormats, the vice chairman at Goldman Sachs International. The two sides, used to fighting with statistics, came as close as they could to meeting face to face: while Fed members deliberated last Tuesday, some 200 AFL-CIOled protesters gathered outside in the first such demonstration against rate hikes since farmers blocked the street with tractors in the early 1980s.

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