E C O N O M I C R E P O R T O F T H E P R E S I D E N T

The Calm Following the StormThe year 1998 had been an especially stormy one for financial markets. TheAsian crisis in 1997 and the Russian debt default in August 1998 had precipitateda series of dramatic events in U.S. financial markets. Investors, includingforeigners, had sought to reduce exposure to risk by selling high-riskinvestments and buying Treasury securities. This “flight to quality” had in turnbid up prices of Treasury securities, driving Treasury yields down (Chart 2-9).Corporate bond premiums (the spread between the yield on corporate bondsand Treasury securities), especially those on high-yield bonds, had risensharply. New issuance of private debt had dried up, and debt markets becameless liquid. For a time in the late summer of 1998, even the previously imperturbablebull market in stocks had turned bearish. Owing in part to concernsthat financial markets were freezing up and that a credit crunch might follow,the Federal Reserve had cut the Fed funds rate three times, in September,October, and November 1998, from 5.5 percent to 4.75 percent.With the economy continuing to surge ahead and the unemployment ratedropping to nearly 4 percent, the 30-year Treasury yield ended the year about125 basis points above its level at the end of 1998. Premiums on investmentgradecorporate bonds fell back to levels somewhat above those prevailingbefore the Russian crisis. Premiums on high-yield bonds stayed elevated relativeto early-1998 levels, reflecting in part the high default rate among busi-66 | Economic Report of the President