TOPICS > Economy

Amid Debt-Ceiling Drama, Interest Rates Have Hardly Followed the Script

August 1, 2011 at 12:00 AM EST
On Wall Street, stocks initially rallied Monday on the news of a debt-ceiling deal, but a weak report on manufacturing killed the surge. Economics correspondent Paul Solman reports on the financial world's reactions to the drama over a debt deal as part of his series on Making Sen$e of financial news.
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JUDY WOODRUFF: And the vote in the House is now final. The debt agreement passed 269 to 161. The “yes” votes included Arizona Democrat Gabby Giffords, who drew warm bipartisan applause and a standing ovation as she returned to the House for the first time since being shot last January.

On Wall Street today, the stock market initially rallied on the news of a deal, but a weak report on manufacturing killed the surge. The Dow Jones industrial average ended with a loss of 10 points, closing the day at 12132. The Nasdaq fell 11 points to close at 2744.

NewsHour economics correspondent Paul Solman spent the day watching the reaction in the financial world, starting with the bond market’s response, perhaps the most vital issue surrounding a possible default.

It’s part of his reporting on Making Sense of financial news.

PAUL SOLMAN: On the Manhattan trading floor of Natixis, one of the world’s largest money managers, the day before what was billed as economic Armageddon for the bond market kicked off quietly. The vote on the weekend’s debt deal was now imminent, but the price of the government’s benchmark 10-year Treasury bond was barely stirring.

Head of U.S. bond trading Abdullah Karatash:

ABDULLAH KARATASH, Natixis: A yield on the 10-year is back down below 2.8 percent.

PAUL SOLMAN: And that’s for borrowing money for 10 years.

ABDULLAH KARATASH: Absolutely.

PAUL SOLMAN: Put this in perspective. What has happened to the interest rate on the 10-year U.S. IOU, the U.S. bond in the last, I don’t know, week?

ABDULLAH KARATASH: The yield has come down significantly. Contrary to what a lot of pundits were saying, that, you know, the U.S. is living beyond its means and people will no longer lend the U.S. government money, that rate has come down even further.

PAUL SOLMAN: We have been hearing the public warnings for months. Debt ceiling dithering was making investors in U.S. bonds impatient. These so-called bond vigilantes were about to demand higher rates to lend us money. But contrary to the warnings, the interest cost to the U.S. government has actually dropped.

So, you mean that, while there was all this terror about the bond vigilantes demanding a higher interest rate in order to lend us money, the interest rate kept going down?

ABDULLAH KARATASH: A lot of that was completely removed from the reality of what actually happened in the market. The market essentially said — excuse me my French — but you’re full of it.

PAUL SOLMAN: In fact, ever since rating agencies Standard & Poor’s first signaled it might downgrade U.S. debt back in the spring, interest rates have been doing anything but follow the script.

ABDULLAH KARATASH: Going back to April 19, when those rating threat announcements came out, as you can see, the interest rate just went lower and lower and lower and lower.

PAUL SOLMAN: And so what explains a plummeting of interest rates when everybody — almost everybody — including, I remember, The Financial Times, certainly The New York Times, was warning that the interest rate was going to go in exactly the opposite direction?

ABDULLAH KARATASH: We had the turmoil in the Middle East, the so-called Arab spring, if you will, and, more importantly, we had the European sovereign debt crisis.

PAUL SOLMAN: So people say, I’m going to take these European bonds that I have got. I’m going to sell them. I have got to something with the money. I’m going to buy U.S. bonds?

ABDULLAH KARATASH: At the end, an investment, a security is only as good as your best alternative. And, frankly, there are no real alternatives in the world to U.S. government debt. So, as profligate as the federal government is — and it has been extremely profligate — investors continue to feel that U.S. Treasury bonds offer them the best source of value for a long-term investment.

PAUL SOLMAN: The U.S. bond market, that is. A wobbly economy is obviously no good for business and therefore no good for U.S. stocks.

And so, though the stock market started the day up more than 100 points, it soon slipped into negative territory.

ABDULLAH KARATASH: Stocks are selling off. And, simultaneously, Treasury bonds are rallying.

As the macroeconomic backdrop gets hairy, investors typically pull of out stocks and move into government bonds, Treasury bonds in this case. With high unemployment, with manufacturing numbers, GDP numbers not all that great, we’re going to see even stronger demand for U.S. Treasury bonds.

PAUL SOLMAN: Meanwhile, over at the currency desk, director of foreign exchange David Durst.

What’s happening to the dollar right at the moment?

DAVID DURST, Natixis: Ah, that’s a good question. The dollar is rallying quite a lot at the moment. That’s the dollar index today.

PAUL SOLMAN: So shooting up?

DAVID DURST: Yes, I mean, ever since they announced the deal was announced last night basically, since the morning, we have basically had a big, big, big thump in the dollar.

PAUL SOLMAN: It’s up against almost every currency, it turns out, save the Japanese yen and the Swiss franc.

DAVID DURST: The Swiss franc is a big gainer vs. the dollar today.

PAUL SOLMAN: They didn’t raise the debt ceiling in Switzerland. Why would the Swiss franc be rallying even against a currency like ours, which is rallying against other currencies?

DAVID DURST: It’s a great question. And the reason is, because as much as the dollar is a safe haven at the moment, Swiss is an even greater safe haven.

PAUL SOLMAN: The flight to safety, that is, seemed to be in full swing.

But the dollar hadn’t been looking all that safe over the past year, given the new dollars the Fed has been printing, says Durst. So was today’s rally triggered by the debt ceiling deal?

DAVID DURST: It has nothing to do with the debt ceiling. This particular debt deal, as it is, if it passes as it is, is almost all spending cuts. It would probably be likely to weaken the economy, not strengthen the economy.

PAUL SOLMAN: So, you mean, because of this debt deal, there would be less government spending, that would contract the economy further, and then the Fed would need to print more dollars to get the economy moving again, which would drive down the value of the dollar?

DAVID DURST: That very well could be correct in the short term. In the long term, a good solid debt deal that would reduce our long-term debt and deficit would be bullish for the dollar, but that would be much — we’re talking very, very long-term. Remember, these cuts are over 10 years.

PAUL SOLMAN: At the end of this day, the 10-year interest rate was down to 2.75 percent, the Dow little changed, and neither much influenced perhaps by the so-called debt ceiling crisis.