As far as the bond market is concerned, the holidays began Wednesday. Theareafter, activity died and prices declined the rest of the week.
It is definitely an eye-opener to view the bond market from the beginning of our sensational rally in mid-March (when bond rates were near their peaks), to the high point of the rally in mid-June (when bond rates were near their lows) to the current levels.
The changes can be observed by comparing Treasury yield curves at those three different times. A yield curve is a graph of different yields of various maturities on a given day. For Treasuries we begin with the 6-month bill and finish with the 30-year bond.
In mid-March, we had a negative yield curve. This means that the 6-month bill offered a greater yield return than the 30-year bond. Normally, longer bonds return more yield, and the curve then has a positive slope. In mid-March, the 6-month bill returned 415 basis points (a basis point is one-one hundreth of a percentage point) more yield than the long bond.
By mid-June, at the apex of the rally when prices had risen to their 1980 highs and yields and declined to their 1980 lows, a postitive yield curve existed. You could move from the 6-month bill into the 30-year bond and pick up 263 basis points.
By the end of last week, the curve had just about flattened out. In going from the bill to the long bond, only a pick-up of 7 basis points was possible.
Also noteworthy was how much of the rally various maturities had given back in 10 weeks. The 6-month bill had given up 47 percent of its yield declines while both the 10-year note and 30-year bond had given up 69 percent of their yield rally.
During this same period new long AA public utility bonds and 20-year AA municipal general obligation bonds surrendered about 80 percent of their gains.
To view this from another perspective, the current market levels existed back in mid-April. Then prices moved higher until mid-June and have declined through the end of August. This means that the $22 billion in corporates, $18 billion in municipals and $47 billion in coupon Treasuries that were sold from mid-May to the present, are all selling at a loss to the buyers.
This is one reason for changes in the yield curves. Investors are being hit with huge losses long before anyone thought the bull market would be over. Consequently buyers are refusing to extend maturities, which necessitates higher yields on longer issues to entice buyers to extend.
Probably the main cause for the recent change is that the market declined in price too much during the earlier part of the year, then roared back to far, too fast during the second quarter, and only now is adjusting to reality. And that reality is an underlying rate of inflation of 10 percent.
Superimposed on all this is the probablility of larger budget deficits, tax cuts, heavy bond financing and a glimmer of an improving economy with continued inflation.
With all the uncertainties, funds should be kept in short maturities. On a relative basis, short Treauries (1 to 4 years) are more attractive than tax exempts (assume a 49% bracket). However, beyond 10 years, tax exempts are more attractive than taxable bonds.