The importance of the bond market to federal budget policies and politics became clear at the beginning of the Clinton administration, when the president himself realized that because of their ability to change interest rates, bond traders in New York might have a bigger impact on the U.S. economy (and, therefore, his political popularity) than he did.
Since then, the budget policies that have been put in place have largely pleased Wall Street. The reduction in the deficit between 1993 and 1997, followed by an increasing surplus in 1998 and 1999, has produced a steady downward pressure on interest rates. Falling interest rates or interest rates rising only slightly increases the value of existing bonds-either in real terms or at least compared to what they would have been worth had interest rates gone in the other direction.
But if the bond market has been happy the past few years because of what Congress and the president have been doing on the budget, it should get positively giddy about what is happening now-and what the policies currently being put in place mean for next year.
First, there is little likelihood of a big budget deal this year. Wall Street likes this because a deal would mean a large, probably multiyear tax cut and spending increase. That would have reduced or eliminated the projected surplus for perhaps each of the next 10 years, and therefore reduced the expected pay-down in the amount of publicly held federal debt.
Federal debt is like most goods: If the supply goes down while the demand stays the same, the price increases. Therefore, bondholders like surpluses that are used to retire debt-it puts downward pressure on interest rates (lower interest rates are the equivalent of higher prices) and makes the value of existing bonds that much greater.
Second, there has been an extraordinary change in how the federal budget surplus is defined on Capitol Hill. Until recently, the surplus or deficit was largely determined by looking at the whole budget-that is, including Social Security. Over the past few months, however, the surplus has been increasingly talked about as something quite different, and smaller-the amount by which revenues exceed outlays not counting Social Security.
If this continues it will be very happy music to the bond market's ears. If Congress and the White House only consider tax cuts and spending increases to the extent that there is a surplus without Social Security, the federal government will reduce publicly held debt every year for quite some time. In fact, the pay-down will continue until the non-Social Security surplus exceeds the Social Security surplus, or until there is no Social Security surplus at all).
Third, one of the biggest gimmicks Congress is considering to get through this year's appropriations mess-advance appropriations-will make it much less likely that there will be a budget deal next year as well. By advance appropriating fiscal 2001 funds now, Congress will be spending almost half of the 2001 surplus that many Republicans had wanted to use to pay for a tax cut. Equally as important is the fact that a large advance appropriation this year almost certainly means that a larger advance appropriation is likely to be considered next year-and that will reduce the 2002 non-Social Security surplus that might be available for a tax cut as well.
From the bond market's perspective, this is all good news. A reduced non-Social Security surplus next year and the year after means that the amount available to offset a tax cut will be too little to pay for most of the revenue changes Congress has been discussing. Congress and the White House could agree to additional spending cuts to be used as offsets, but so far neither has been willing to consider them seriously. They could also agree to change the budget process rules, but that will be all but impossible with the narrow majorities and pre-election environment that will exist next year.
Without some major change in the economic outlook that pushes Washington to take some action, no tax cut makes an overall budget deal in the next two years highly unlikely. From Wall Street's perspective, that means more federal debt repayment than would otherwise occur.
But won't bond traders get upset enough to raise interest rates because of the growing likelihood that Congress and the president will end up busting the cap on fiscal 2000 appropriations by $30 billion to $40 billion? Not really. Wall Street has long assumed that the caps would be breached and has already priced that into the market, so there should be little or no impact on rates when the appropriations actually end up over the limit. In addition, while $40 billion is a substantial amount by most standards, as a percentage of either expected total federal outlays in fiscal 2000 or the economy as a whole (both of which are far more important than the nominal size to the bond market), it is almost insignificant.
Question Of The Week
First, some unfinished business from the question of two weeks ago. The first continuing resolution for fiscal 2000 will expire at midnight on Thursday, Oct. 21. Although no one guessed that precise day, two readers did send answers that were one day off. After much deliberation (actually, by flipping one of the new 50 state quarters issued by the U.S. Mint) the "I Won A Budget Battle" T-shirt goes to Susan Friedman, director of congressional and constituent relations at the American Osteopathic Association.
Last Week's Question. This was a tough one. Only two people knew what happens if Congress does not formally adjourn and a sequester, which is supposed to happen 15 days after Congress adjourns, is needed. The answer: the sequester takes place 15 days after the first session of Congress officially ends, which is usually noon on the first Tuesday in January. The two correct answers came from two previous T-shirt winners-Richard Kogan of the House Budget Committee, and Paul Van de Water, who has just joined the Social Security Administration after a distinguished career at the Congressional Budget Office. Both will get "I Won A Budget Battle" T-shirts.
This Week's Question. Here's a soft pitch for everyone. If you were a driver on a road called "Federal Budget Boulevard," what traffic sign ("Yield," for example) would you be most likely to see? Send your answers to scollender@njdc.com and you might win an "I Won A Budget Battle" T-shirt to wear while watching the major league baseball playoffs.
Nominate Your Choice For The 1999 "Black Ink" Award
For the second year in a row, "Budget Battles" is presenting the "Black Ink Award" to the person or organization that readers select as having the most positive impact on this year's budget debate. Nominations, which can only be made via e-mail, will be accepted through Friday, Oct. 29 (Only one nomination per person will be accepted.) Through November, readers will be given a chance to vote for one of the top five nominees. The winner of the award will be announced in the final Budget Battles of 1999.
NEXT STORY: House leaders rally around across-the-board cut