Death of 30-Year Bond Good For Consumers

Let's face it: stocks are a lot sexier than bonds.

Everyone pays attention when the Dow Jones Industrial Average or the Nasdaq Composite Index delves upward, downward or sideways.

Yet a tick up or down of the 30-year Treasury bond usually doesn't do more than prompt a bunch of confused looks and yawns among average investors. For most Americans, the bond market just conjurs up images of images of slicked-up traders with red suspenders and cigars shouting gibberish involving fractions and other weird math.

But in recent days the bond market is turning heads — and for good reason. The Treasury Department's elimination last week of the 30-year bond and the subsequent reaction in the bond market effectively gave U.S. consumers, homeowner and companies one of the biggest break in interest rates ever seen.

Financing the Government's Shortfall

But first, it helps to understand why the U.S. government issues bonds in the first place.

Since the Second World War, the government has sold various denominations and durations of bonds to help finance the shortfall between what it spent and what it brought in from taxes and other revenue. The government would sell the bonds to primary dealers, who would then trade them back and forth in similar fashion to stocks.

The 30-year bond was born as the U.S. government entered a period of massive deficits under former Presidents Jimmy Carter and Ronald Reagan. Sales of the bonds helped finance an explosion of government spending, tax cuts and entitlement programs.

Its fate was sealed in the 1990s, when former Treasury Secretary Robert Rubin, former President Bill Clinton and the Republican Congress agreed on a plan to balance the budget. The booming economy quickly moved the government into the black, eliminating the need to issue new fixed-income securities.

Mortgage, Loan Rates Falling Fast

Now, back to the 30-year bonds. Prior to the Treasury's surprise announcement last week, bond yields were already falling, bringing mortgage rates and other rates on loans down with them and prompting waves of homeowners to refinance and renegotiate their mortgages. But they weren't falling as far and as fast as other shorter-term rates.

At least until last week. The demise of the 30-year bond under the Treasury Department edict means the increasingly scarce securities will gain in value over time — dropping yields — as bonds are gradually removed from the market, either via the government buyback program or expiration.

The yield on the 30-year bond now hovers around 4.80 percent, all but ensuring that mortgage rates and other rates tied to medium- and long-term market investments keep falling. That, in effective, gives the struggling U.S. economy a boost equivalent to a Federal Reserve interest rate cut. At its peak, the bond yielded 15.20 percent. At its low, it paid 4.70 percent.

"The Treasury eliminated one of the things that was holding yields up," said James Paulsen, chief investment officer at Wells Capital Management in Minneapolis. The decision will probably give "the consumer a refinancing stimulus" by lowering rates that move in tandem with the bond market.

"The drop in the yield on the long bond will likely cause a refinancing boom the likes we've yet to see," added Kim Rupert, a senior analyst with Standard & Poor's MMS in San Francisco. "The extra monetary stimulus it should engender could leave the Fed on a less aggressive track when it meets on Nov. 6."

Mortgage refinancings have surged this year as rates have fallen. According to the Mortgage Bankers Association's weekly applications survey, the index that measures refinancings jumped to 5252.6 in mid-October from 1257.7 at the start of the year — a fivefold gain.

While many are anticipating the government will once again have a shortfall in the wake of the Sept. 11 attacks and the billions being spent in defense and stimulus, few expect it will be a long-term situation that would require a return of the 30-year bond.

"What the bond market is currently pricing in an economic turnaround," said Dennis Hynes, bond market strategist with R.W. Pressprich & Co. in New York. "The basic sense is that uncertainty will continue in the short term and the Federal Reserve will continue to lower rates, but longer term there are expectations for a pickup in economic growth, which would alleviate the government's need to borrow."