All markets abhor uncertainty. In this kind of an atmosphere, it becomes impossible for investors to have convictions that are firm enough to guide the markets in a specific direction. Where uncertainty exists, so does volatility. And volatility has become the watchword for the bond markets.
The rally that began on Friday, Aug. 22, continued through most of last week. The scene was ripe for a good rally. The corporate calendar had dried up due to higher rates, the Treasury was unusually absent and the municipal calender was slight. On top of this the bond markets had just come off a large and probably overdone selloff when the rally began.
In fact, the government bond dealers had purchased most of the $3 billion, 5-year note issue and were trying to hedge their precarious situation by selling issues they did not own against their 5-years (short selling). When investors perceived that the Federal Reserve was not going to tighten credit as they had feared, the rally was on and prices increased -- fast.
Treasuries jumped anywhere from 2 points to 4 points in three days as the dealers who were short certain issues (that they didn't own) were forced to buy in those issues (as prices rose) to "cover" their short positions.
Unfortunately there was one thing missing and that was legitimate retail buying. Consequently the Treasury rally faltered as the dealers played "hot potato" with their bonds. And this all throws back to the confusion on the part of both the dealers and the investors in the marketplace.
The investor has been burned so many times in the past two years that he is gun-shy and simply does not want to extend into longer maturities despite being able to pick up large increases in yield.
This poor psychological frame of mind comes from confusion over monetary policy, confusion over the direction of the economy and inflation, confusion as to the end result of fiscal policy and portfolios full of losses from past purchases. As these doubts are removed, direction will return to the markets but it looks as if volatility will be present for a long while.
For those tax-exempt investors who wish to remain in short maturities, over $1 billion worth of U.S. government-backed project notes will be offered on Tuesday. These notes mature in anywhere from four months to one year. The returns should be somewhere around 6 percent in six months or to 6 1/4 percent in 12 months.
Also of interest is the $125 million State of Massachusetts general obligation issue which sells on Tuesday. These bonds mature serially from 1981 through 2000. In the past they have been rated A-1 by Moodys and AA -- by Standard and Poors.
Ed Hosinger, director of municipal research at Oppenheimer & Co., feels that this issue could be a sleeper. Using the 20 year maturity as a guide, Mr. Hosinger points out that the market values Massachusetts debt around 100 basis points more (cheaper) than the highest grade states -- i.e. Texas and North Carolina.
Due to good growth trend in the commonwealth's economy, a stable debt burden for the past three years and a fiscal 1981 budget that is attainable and therefore should not impair liquidity. Hosinger believes that the Massachusetts debt -- at a 100 basis point spread -- is being overly compensated for any risk and that the spread will close up in the future. This would be especially true if we have a short recession and the state's liquidity were not impaired. If this happens, the state could be a possible upgrade candidate.
Investors who are interested in 6-month money market certificates have until September 10th to lock up the attractive 10 1/2 percent return that is now available.