Bond prices rose and short-term interest rates fell today as investors and traders became convinced that the Federal Reserve wouldn't find it necessary to take further steps to tighten its already stringent monetary policy.
For its part, the Fed entered the money market today to inject funds into the banking system, although analysts said the move doesn't mean the central bank is acting to ease up on tight money.
The rallies in the bond and money market followed disclosure by the Federal Reserve late Thursday that it had sharply overstated the rate of growth in the money supply during the previous two weeks because of a $3.7 billion reporting error on the part of one of the nation's major banks.
Last week the Fed reported a big $2.8 billion increase in the money supply -- currency in circulation and checking accounts -- despite the stringent measures it took on Oct. 6 to slow the growth of money and credit.
The Fed said Thursday that the money supply actually declined $200 million last week and that it declined another $700 million this week.
The Fed wouldn't identify the bank that made the error.
But today Manufacturer's Hanover Trust Co., New York's fourth largest bank, admitted it made the error which threw off the Fed's figures.
The bank said the error was caused by the use of a new form on which it recorded deposit data but that the error had no effect on "the integrity of Manufacturer's Hanover's financial records or previously issued financial statements."
The mistake angered many bond traders and others who feel they lost money this week because investors believed the central bank would have to tighten even more to contain that $2.8 billion surge in money. The report of the increase last week kept financial markets in confusion and helped push short-term interest rates higher. When interest rates rise, bond prices fall.
But bond prices rose today because of the Federal Reserve's revised money growth figures. Furthermore, according to Lawrence Kudlow, chief economist for Bear, Sterns, Inc., the markets also are beginning to adjust to new Federal Reserve policies.
In announcing the stricter monetary policy Oct. 6, the Fed also said it would change the way it operated on a day-to-day basis, focusing less on interest rates and more on the growth of bank reserves, the prime ingredient in the creation of credit and money.
Because the Fed no longer was there to guide interest rates and because of the fear that this created, short-term rates rose sharply during the last three weeks.
"Now we're beginning to return to normalcy," said Kudlow. "Our traders are in good spirits again for the first time in three weeks."
Tom Kane of the Bank of New York said that short-term interest rates on Treasury bills fell a half percentage point or more today, while Treasury bond prices rose between one point and two points (each point is worth $10 on a security with a face value of $1,000).
Next week, however, the Treasury will sell $6.75 billion of notes and bonds, which will increase the supply of government securities and put some new downward pressure on their price, Kane said.
Both corporate bonds and municipal bonds, which have taken a terrible beating in the last three weeks (falling as much as $100 on $1,000 in face value) began to recover today, too.
Nevertheless, some major banks, led by New York's largest, Citibank, raised their prime lending rate to 15.25 percent, surpassing the 15 percent level set earlier in the week.
The increase reflects interest rate increases that have been occurring since Oct. 6.