Global bond managers are not even flinching at the prospect of a governmental "train wreck" should Congress and President Clinton reach an impasse in budget and debt ceiling negotiations.
While many Americans are either clenching their teeth or rejoicing over the coming confrontation, bond managers don't care if the government shuts down for a few days or weeks. They seriously doubt the U.S. Treasury would fail to make good its interest payments on its debt.
Rather, they say the real issue is how fast the U.S. economy is growing.
"We've seen these cliffhangers on the debt ceiling before," said Gordon Johns, managing director, Kemper Investment Management Co. Ltd., London. "The history of these things is that they get done in the end."
Echoed Paul Cavalier, assistant director of investments at Lombard Odier International Portfolio Management Ltd., London: "I don't think the market is that concerned with the U.S. defaulting..... It would be such a catastrophe that people would perceive the U.S. Treasury to be stabbing itself in the foot."
Government officials are "not stupid people. They know they have to pass it one way or another," he explained.
Already, government is proving investors to be right. President Clinton and congressional leaders are negotiating a short-term spending bill. That way, they can avoid an Oct. 1 shutdown of most federal activities, while they wrangle over longer-term spending bills.
More contentious than spending issues, however, are tax cuts affecting Medicare, Medicaid and welfare, where Republicans and Democrats part company.
And more threatening is the expected need to extend the federal debt ceiling, now at $4.9 trillion. If Congress fails to authorize an extension, in theory the government could default on interest payments on its debt. Assuming a short-term budget bill is passed, deadlines for adopting longer-term budget bills and the debt-ceiling extension will be in mid-November.
Normally, the prospect of the government shutting down or the Treasury unable to meet its interest payments would roil bond markets. This time, however, bond managers say the direction of the U.S. economy is the relevant issue.
The economy is growing at a moderate rate this year and inflation has been tamed, experts said. A 0.1% decline in the Producer Price Index last month and a modest 0.1% rise in the Consumer Price Index support this view. Investors expert inflation to remain around 3% or lower.
The question is how fast the economy will grow. At the most optimistic end of the scale, John Lonski, senior economist for Moody's Investor Services, New York, projects growth at 3% for the second half of this year, boosted by higher motor vehicle sales and strong retail sales.
John Stopford, investment manager at Guinness Flight Global Asset Management Ltd., London, added business inventories have been cut back, while income and job growth has been strong. The weakest point has been net exports, he added. Plus, there is "some concern that we are getting to the end of the investment boom in the States," he said.
Still, conditions are strong enough to allow the economy to grow at a 2% to 3% clip over the medium term, he said.
John Monckton, head of the fixed-interest department at Foreign & Colonial Management Ltd., London, said the economy should pick up from its 1.1% annualized growth rate in the second quarter. Consumer demand has risen, the housing market is improving and net exports will be less of a drag on growth than in the past, he said.
Mr. Monckton sees growth rates rebounding to nearly a 2% annual level late this year and into 1996. Meanwhile, U.S. government debt is a relatively low 2.25% of gross domestic product. If the budget deficit hits forecasted levels of $174 billion in 2000, that ratio would fall to 1.8%, he said.
David Torchia, director and senior portfolio manager at Salomon Brothers Asset Management, New York, said an increase in retail sales in the second half of this year should boost the annual growth rate to about 2%.
Taking the opposite view is Steve Smith, executive vice president, Brandywine Asset Management Inc., Wilmington, Del., who predicts growth at a more modest 1.5% rate for 1995's second half.
Mr. Smith says consumers will take a rest from their spending. "At some point they have to take a breather, and I think we're at one of those points," he said.
Despite strong U.S. growth prospects, global bond managers are looking elsewhere for returns. Most say they are overweighting European bond markets, seeking higher-yielding markets with greater prospects of further interest-rate declines. (The yield curve on U.S. bonds is fairly flat; the yield on the 30-year Treasury is 6.5%, only 75 basis points over the Federal funds rate.)
Guinness Flight's Mr. Stopford favors the high-yielding markets of Italy, Spain, Sweden, Denmark and the United Kingdom.
Similarly, Lombard Odier is heavily overweighted in the high-yield markets of Italy, Sweden and Spain, anticipating further interest-rate drops, Mr. Cavalier said. The firm is playing the longer part of the yield curve.
But some of the most intriguing stories are occurring in other dollar-related markets. New Zealand's 10-year bonds offer a 160-basis point spread over U.S. Treasuries. The country's well-managed central bank has kept a tight rein on inflation, experts said.
New Zealand "still has got the most anti-inflation and dirigiste central bank" in the world, said Kemper's Mr. Johns. Kemper has a 10% weighting in New Zealand bonds, compared to the Salomon Brothers World Index weighting of only 0.2%.
But a major political shift is coming, as New Zealand's method of election changes next year from first-past-the-post to proportional representation, Mr. Johns said. The result probably will leave no single party in control, creating some political risk. But the current government already lacks a majority as defectors leave to set up new parties.
Stephen Fitzgerald, executive director, global fixed income, at Goldman Sachs Asset Management, London, said the spread between 10-year New Zealand bonds and U.S. Treasuries is attributable partly to liquidity concerns, and partly to credit risk.
But New Zealand's high yields also stem from a general lack of knowledge of how well economic reform has worked there, he said. The country got caught in last year's global widening of yield differentials, which in New Zealand's case was not justified, Mr. Fitzgerald said.
The other compelling story is in Canada, where the 10-year bond is trading at a 188-basis-point premium over U.S. bonds. The spread has widened in anticipation of an Oct. 30 referendum in Quebec over whether the French-speaking province should become a separate state.