While the world waited for the administration to produce its plans to combat inflation, a slowing economy and an energy crisis, the fixed income markets received news that will certainly lead to higher short-term interest rates and possibly longer rates as well.
One consequence of supporting the dollar overseas for the past several years has been rising inflation in Germany and Japan. Recently, with all the domestic problems, the dollar has once again come under selling pressure abroad. Half of the dollar's gain against the German mark since Nov. 1 has been lost in the past month.
To combat inflation the Germans on Thursday raised their discount and Lombard rates (the rates charged by the central bank for loans to member banks).
On top of this, the monetary aggregates continued to grow at an alarming rate, especially M-2 which is the broader measure of our money supply.
What this means is that at a time when our economy is slowing, the Fed would ordinarily ease money and interest rates, and as a result short term rates, especially, would fall.
However, the Fed and the administration now find themselves squarely in a box. The slowing economy dictates the easing of interest rates. But a weak dollar abroad, a growing money supply, a high rate of inflation and rising interest rates overseas call for higher interest rates here at home.
The rising rates abroad concurrent with a determined effort on the part of Germany, Japan and Britain to curtail inflation will cause an outflow of dollars from the United States. These dollars will be sold (which will further weaken the dollar) and currencies of those countries will be purchased (which will cause them to appreciate) to buy their securities.
Consequently the United States cannot ease money policy now or the outflow will worsen. Probably short rates will have to rise to check the dollar outflow.
This means keep your money short and liquid as short rates should begin to rise again.
The other big event was the $591 million New Jersey Turnpike issue that almost made it to market. The issue was priced and oversubscribed but because of "legal problems" the issue was never relased. These legal problems and the fate of the lion will be decided this week.
The real heart of the matter is that the Internal Revenue Service took a dim view of the apparent violation of its arbitrage rule. The interest to be paid on $448 million of the bonds was 4 1/2 percent. However, the proceeds of the sale was to be invested in Treasuries earning 9 percent or more. Such a move will probably be disallowed.