Rout in Bonds

Sears, Roebuck & Co. last week announced plans to sell a $350 million bond issue, the largest industrial bond offering in U.S. history. But before signing a contract with its underwriters, Sears said it wanted to take a careful look at conditions in the bond market. What particularly alarmed Sears and other prospective corporate-bond issuers was the situation in U.S. bonds. After a year-long rise, Government bonds were going through the fastest, worst shakedown in postwar history, causing dealers to employ such expressions as ''chaos," "rout" and "panic."

Although corporate bonds were holding up much better than Governments (see chart), the sharp decline in U.S. bonds was pushing up the cost of money for Sears and other prospective private borrowers. As the price of Government bonds fell, their yields rose sharply. Last week a recent issue of long-term Government bonds paying a coupon rate of 3 1/4% was actually yielding more than 3 5/8%. A recent issue of relatively short-term bonds with a 2 5/8% coupon was yielding 3 1/2%.

The bad drop in U.S. bonds stemmed largely from speculation. Because there is no margin requirement on Government bonds, speculators have been able to buy them for as little as 2% in cash. Last winter and spring, as credit eased, speculators correctly guessed that Government bonds would rise. Buyers poured into the Government bond markets and made a killing, as competition among bond buyers pushed prices of new issues far above par. For example, the 3 1/2% bond that came out in February was bid up to 107.10, a price that gave speculators a profit of 250% on their actual cash investment.

Fed Fumble. But in June the merry-go-round slowed down, as the recession bottomed out and business started up. Speculators, anticipating renewed inflation and Government tightening of credit, started getting out. As Government bond prices fell, shoestring speculators were forced to dump their holdings, driving down prices more. One new Treasury issue, the 2 5/8% bonds, fell to 95.16 last week, despite the Treasury's unusual step, in July, of buying back nearly $600 million of the issue. An even sharper skid hit the 3 1/4% issue: it dropped to 93.12.

In an attempt to halt the drop, the Federal Reserve Board fumbled the job, adding to the trouble. The Fed, which regularly buys 91-day Treasury bills as part of its normal operations, cryptically announced that it was "broadening" its open-market operations. This led many to believe that the Fed intended to buy enough long-term bonds to cushion the market; it gave courage to the market, attracted buyers back into bonds. But the Fed's purchases were limited to buying $1 billion of one-year certificates to aid the Treasury's July refinancing operation. As the effect of this wore off and hopes for more substantial assistance faded, the shock of disappointment sent bonds down some more. Last week, in raising margin requirements on stocks, the Fed signaled possible new moves to tighten credit--and bond prices fell again.

Nip the Recovery? The man with the most reason to be concerned about all this is Treasury Secretary Robert Bernerd Anderson. He must raise up to $12 billion in new financing this year to cover expected budget deficits, and also has to refinance $46 billion in maturing securities. This formidable financing chore comes at a time when yields on recent U.S. bonds are sharply rising. If Anderson raises the coupon rate on forthcoming issues to match the competition from older bonds, he will tend to raise all interest rates. Such a course might well nip the general business recovery. At the same time, unless Anderson takes this chance, he can hardly hope to get the money he needs.

Anderson's best hope is that the bond market will bottom out, and that rising yields will tempt investors back into bonds. But the big question is whether tempting yields are big enough to overcome investors' fears of more inflation--and an inevitable drop in present bond prices.

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