If you follow the federal budget, the story of Bill Clinton and the bond market has taken on almost mythical qualities.
Based on the advice of then-National Economic Council Director Robert Rubin, early in his first term of his presidency, Clinton realized he had to pay attention to the big impact his budget policies were going to have on interest rates. Ever since then, Washington supposedly listens whenever the bond market vigilantes speak.
And in recent days they have been increasingly speaking about what should be done with the budget. Supposedly because of their unhappiness with the outlook for federal deficits and government borrowing, interest rates on treasuries have been rising. This has slowed mortgage refinancing, raised concerned about the ability of would-be buyers to purchase a home and, in general, raised questions about the economy continuing to recover.
At least partly because of the bond market vigilantes, the change in the budget economic discussions has been astounding.
Two weeks ago, the financial and business news channels were complaining loudly about how long it was taking for federal stimulus dollars to be spent. That has now changed to a concern about whether the government should spend the money at all.
Until very recently, many of the most highly regarded bond market analysts were saying they werent convinced that the more than 30 percent increase in the Dow Jones Industrial Average that has occurred since March was real and were using phrases like bear market rally and dead cat bounce to explain what was happening. That meant money was continuing to flow into bonds rather than stocks because of what many saw as the continuing risk in equities.
Over the past two weeks, that skepticism seemed to have turned almost 180 degrees as many of the same analysts who previously were astonished when the market had an up day began to express surprise when a rally didnt continue. Instead of triggering the triple-digit drop in the Dow that had been typical of the past year, bad news suddenly has the stock market always looking for the pony. As a result, money that had been flowing into bonds from stocks started to move in the opposite direction.
And even though there are few real indications that its actually happening, the extreme concern about deflation that had been dominating the economic headlines over the past year has been replaced in the past few weeks by a not-so-subtle worry, not just about higher prices, but what the vigilantes say will be roaring inflation.
To a certain extent, all of these changes are a good thing because, at least on Wall Street, there appears to be a growing belief that the economic outlook is improving. Many statistics are being interpreted far more positively now than was the case less than a month ago, and thats having a further positive impact on what investors are thinking and doing.