New York market: Inflation fears dampen appetite for bonds

INFLATION is low, US bonds offer higher yields than those of most other countries, and the government is paying off debt. So why are investors sour on bonds? It is the nagging concern that relentless economic growth - evidenced by jobs, manufacturing, earnings and spending - will lead to inflation later.

"The economy is firing on all cylinders,'' said Kevin Kennedy, a portfolio investor at Citibank Global Asset Management. "Growth has to slow a little bit, or there will be inflation pressures." Another reason to fret about inflation comes from prices for crude oil, which are up 57 per cent so far this year. Crude oil closed above $20 (pounds 13) a barrel last week, for the first time since November 1997.

With all that working against bonds, the benchmark 30-year Treasury bond is down 8.1 per cent in 1999, reflecting price declines and reinvested interest payments. Mutual funds, used by most individuals who buy debt, have suffered, too.

Many investors say they are on guard for further bond declines. Steve Merrell, manager for American Express Asset Management, says the vigorous economy could boost 30-year yields to 6.25 per cent in the months ahead. "The laws of economics eventually will kick in - you should start seeing some inflation pressures," Mr Merrell said.

Possible problems later are overshadowing the week's good news: consumer prices were unchanged for the second straight month in June, the first such performance since 1986. This helped boost bonds last week. The benchmark 30-year Treasury bond rose about 1.5 points and is up 1.4 per cent in July, on track to post its first monthly gain since January.

With 113 companies of the companies in the S&P 500 having reported second- quarter earnings so far, investors say they are pleasantly surprised. This may push stock prices, already at record highs, even higher.

This week marks the busiest reporting week for the quarter, with Citigroup, IBM, America Online, and Microsoft among the 150 scheduled. Investors are optimistic that most companies will match or even beat expectations, and the only cap to climbing stocks may be bond yields.

"It's not out of the realm of possibility that by mid-August the Dow could be at 11,800," said Robert Froehlich, chief investment strategist for Scudder Kemper Investments.