Throughout these columns, we often refer to the fundamental and technical reasons for price changes in the market.
The fundamentals refer to the basic underlying events which in themselves should govern the direction of the market -- the health and vitality of the economy, for instance. If the economy is strong, there should be a strong demand for credit at all levels to finance a growing economy. This in turn has a direct effect on short and longterm interest rates. In the past two years, the demand for credit has helped push interest rates to peak levels.
If on the other hand, an economy is weak or in a recession, the demand for credit likewise will be weak and interest rates will decline. This is precisely what happened during the second quarter of 1980. High interest rates and the credit controls which were applied in March caused the demand for credit to dry up and interest rates to plummet.
Technical considerations refer to interim events that influence the markets one way or another, such as the recent heavy housing revenue volume in the municipal market. In general this pushed the rates of all tax exempts higher while, specifically, the rates on the housing issues were pushed to peak levels.
There is a constant tug of war between the basic underlying fundamentals and the ever changing technical considerations in the day-to-day direction of the market.
Through the month of December, positive technical factors have caused both long and short-term rates to decline from their peaks; short rates by as much as 300 basis points and long rates by 100 basis points.
More and more the long market is being influenced by the financial futures market, which played a big part in the recent rally. The decline on short rates also has helped long prices move up.
Short rates have fallen mainly because of a lack of supply of short money market securities. Many commercial banks stopped issuing certificates of deposits to gain funds which rates for those instruments went above 20 percent. The high cost of carry also prohibited dealers from carrying any short inventory. Treasury bills, which are sold weekly, are the only merchandise available in size. As customers eagerly sought Treasury bills, these rates declined 200 or more basis points.
Retail customers seeing these short rates declining began to lengthen into six-month maturities, which brought these rates down by 300 basis points since there was little supply. Also, thrift institutions began buying six-month bankers acceptances and certificates of deposits at a much higher return than they had to offer on their six-month Treasury bills. This, too, forced short rates lower.
In the meantime, the Federal Funds rate, the rate banks lend their excess reserves to one another, bounced all over the lot going as high as 25 percent last week. The Federal Reserve was helpless to supply reserves to the system by purchasing securities from dealers because the dealers had no inventory to offer. Again, technical considerations distorted price movements away from the underlying fundamentals. c
As 1980 closed in a whirl of confusion, it would appear that technical factors have lowered both short and long rates. As these factors correct themselves in the next weeks, both short and long rates should move higher again although not to the peak levels of early December.
The Treasury will offer a 20-year bond on Tuesday in minimum denominations of $1,000. The return is likely to be 11.95 to 12.1 percent.
Also on Tuesday, more than $1 billion of project notes, backed by the federal government, will be sold. These short-term, tax-exempt notes, 3-, 6- and 9-month maturities should return between 7 1/4 to 7 1/2 percent. Actual settlement will be Feb. 3.