The 1994 bond market massacre is remembered with horror by those who lived through it. Yields on 30-year Treasuries jumped some 200 basis points in the first nine months of the year, hammering investors and financial firms, not to mention thrusting Mexico into crisis and bankrupting Orange County.
The accepted story is that an over-eager Federal Reserve set off the carnage by raising interest rates too soon – the sort of premature move that current Fed Chairman Ben Bernanke has suggested, again and again, that he is not going to make.
But what if the conventional wisdom about 1994 is wrong? Steven Englander, Citigroup’s head of G10 currency strategy, says that when it comes to the Fed’s balancing act of a mandate – price stability and full employment – the Greenspan-led incarnation, in this instance at least, deserves top marks.
The Fed’s tightening cycle, which began with a modest 25-basis-point hike in February, pushed short-term interest rates up by 2.25 percent by the end of the year. Yes, Treasuries and the dollar took a beating. But by 1995, the Fed could point to a lower jobless rate (5.5 percent vs 6.5 percent in early 1994), falling inflation and slower compensation growth. And, of course, an economy and stock market that were about to take off.
In other words, 1994 was a great success, at least in terms of the dual mandate. To the FOMC, inflicting pain on over-leveraged bond investors may well have seemed an acceptable price to pay.