The fixed-income markets were crushed last week. Prices on securities tumbled and yields rose accordingly. Short three-month rates increased anywhere from 12 basis points to 50 basis points. A basis point is one one-hundredth of a percentage point. Intermediate Treasury yields rose 25 basis points, while long Treasury bonds were up 30 basis points.
As to the "why" of it all, I quizzed several market participants about the complete turnaround in interest rates since mid-June. These are some of the answers.
Jim Stanko of Carroll McEntee and McGinley: "I am totally confused as to where the Fed stands and what they are trying to accomplish. Why did they reverse course in the past two weeks for no apparent reason?"
A municipal bonds salesman: "A lack of Fed leadership and great disappointment with what the Fed has done, (or not done). With a decline in monetary aggregates and loans, many people had felt the Fed would continue to ease credit and reduce short term rates. This in turn would increase borrowing and help to stimulate the economy."
George Grimm of W. E. Pollock pointed out: "The Fed is concerned about inflation." He also said, "the Street is loaded with paper." The recent offerings of the 2-year note and one-year Treasury bill were purchased by the dealers but as prices fell, the issues were never sold to customers.
As to the short rates, a Merrill Lynch trader noted "the rise in the Fed funds rate (on Thursday) to 10 1/4 percent killed the short term market." A week before the level of the funds rate, which indicates the ease or tightness of reserves in the banking system, was thought to be around 8 1/2 percent. This rate, which is directly influenced by the Fed, is used to decipher Fed policy. In this instance the large increase would indicate a tightening on the Fed's part.
An associate from a large commerical paper house said, "The demand for funds by corporations is exceedingly strong. The demand for short term commercial paper by investors is also strong. And the investor is demanding both quality and liquidity."
Finally Peter Gordon, who manages the Rowe Price municipal fund, offered these observations. "There is a large body of opinion that thinks interest rates are going to rise. The shape of the yield curve confirms this. An investor is enticed to extend into longer maturities by large pickups in yield, yet the demand for short term paper (liquidity) keeps short rates low."
In fact, six-month government-backed project notes are offered around 4 percent, while 20-year prime municipal general obligation bonds are available around 7.8 percent -- a wide spread of 380 basis points.
So it is with these uncertainities that the Treasury will offer three issues this week totaling $8.25 billion. On Tuesday a three-quarter-year note will be sold in minimum denominations of $5,000. Estimated price on that would be 9.95-10.1 percent.
Wednesday, 10-year notes will be offered in minimums of $1,000. They should return around 10.65-10.75 percent.
Finally an existing 29 1/4-year bond will be reopened and auctioned on Thursday -- also in $1,000 minimums. These long bonds should return 10.6-10.75 percent. Small investors should enter noncompetitive bids. Full payment must be submitted with each tender.