The economic news that was released Friday morning indicated a substantial growth in inflation and was understandably bad for fixed-income securities. With the markets reeling, the Federal Reserve, in an attempt to regain credibility, raised the discount rate to 13 percent. The discount rate is the interest member banks must pay for borrowing from the Fed.
The upshot of these events will be lower prices and higher interest rates throughout the various maturities. All of this continues to hurt both the underwriters and investors.
During the week, Treasury dealers still were burdened with inventory from the recent refunding. One pension fund reportedly purchased about $300 million of the new 30-year bonds in the auction at an average price of 99 1/2-$995 a bond and then sold them out around the 101 ($1010 a bond) level during the rally. This also added to dealers' inventories.
The biggest event last week was the sale of $1.4 billion project notes by the Department of Housing and Urban Development. These government-backed short-term, tax-exempt notes were offered initially on levels of 6.40 percent for the September paper and 6.60 percent for the December paper. A $300 million order from benefactors of the sale of the Belridge Oil property sparked an even greater demand for the notes, and by week's end the September notes were selling at a 5.95 percent level while the December rose to a 5.75 percent level.
Outside of the very short end of the markets, which continue to hold up well because of investor demand for liquidity and safety, the longer bond market remains a disaster. No new issues are quick sellouts. Many negotiated municipal deals are repriced cheaper to facilitate sales. Corporate loans generally languish, and occasionally if the underwriters are lucky a deal will sell out at its original price.
The fact that the fixed-income markets are in deep trouble is indisputable. As Peter Gordon, manager of last year's top-performing municipal bond fund at T. Rowe Price, explained: "There exists a crisis in confidence right now in the marketplace, and until we see some event that will change the psychological mood of investors, we're in for a period of more of the same." Many feel that raising the discount rate is definitely not enough to change the mood of investors.
With this in mind it might be wise to recall a number of short-term investments that are available.
First off, money martket funds currently returning 12 1/2 percent to 14 percent are available for an initial outlay as small as $1,000. These are excellent for small investors and offer safety, liquidity and a high term.
There are also two tax-exempt money market funds available, one run by Fidelity Bank in Philadelphia and the Vanguard-Warwick fund in Valley Forge, Pa. However, an individual needs to be in at least in the 59 percent tax bracket before these funds would be attractive.
Treasury bills, which come in minimum denominations of $10,000, can be purchased weekly from any Federal Reserve Bank or the U.S. Treasury here without a fee or through a bank or brokerage house for a fee. T-bills are highly liquid, top quality and are not subjected to state and local taxes.
Project notes, bond anticipation notes (BANS), tax anticipation notes (Tans), and tax and revenue anticipation notes (Trans) are all short -- 6-month to 1-year -- tax-exempt paper. They come with various quality ratings and in a minimum size of $25,000. For a person in the right tax bracket, these returns of 6 percent to 7 1/2 percent are most attractive.
The calendars are light in this holiday-shortened week. However, the Treasury will auction a 2-year note on Wednesday that will come in minimum denominations of $5,000. Small investors should enter a noncompetitive bid at any Federal Reserve Bank and their branches, or at the U.S. Treasury here. A price guesstimate would be between 13.05 and 13.15 percent.