It has been a long time since the direction of interest rates was clear-cut, and last week's activities added to the confusion.
Reflecting these uncertainties, the market itself was on a roller coaster. But with all the crosscurrents swirling around the markets, that's easy to understand. Considering the following items:
President Reagan's speech. Certainly a prescription that could help our economy as well as the stock and bond markets. But, left to the deliberations of Congress, we do not know when and what the end results will be.
Is the Federal Reserve allowing interest rates to decline? In the week ending Jan. 9, the average federal funds rate (the rate that banks charge each other for the use of their excess reserves) was 20.26 percent. On Thursday, this rate fell as low as 14 1/2 percent before rebounding above 15 percent. It was this decline that lifted the bond market after the presiden's speech, and not the speech itself.
But, has the Fed reached some accord with the administration to allow rates to decline for fear of activating the budget processes that increase spending and deficits during an economic decline? Or has the Feb taken into consideration the precarious financial condition of the thrift institutions in the Northeast caused by high interest rates, and begun moving to head off any bankruptcies that could occur? Or has the Feb looked at the depressed auto and housing industries and decided to keep them?
Or perhaps the Fed funds rate has declined because bank credit has fallen off and banks are flush with reserves or can obtain them cheaply in the marketplace.
The confusion about easing arises in that the economy still shows no signs of slipping into a recession. In fact, one could say that the high interest rates have not succeeded in subduing the economy and that the odds have increased that there will not be a recession.
Whatever the reason, it is interesting to note that as the short rates have declined over 500 basis points, long Treasury rates have increased about 125 basis points. In contrast, during the spring rally in 1980, when the Fed funds rate declined 500 basis points in April, long Treasuries dropped about 174 basis points.
Also of interest, as short rates declined on Thursday and Friday and the bond market improved, the stock market lost 10 points -- most unusual when interest rates are declining.
Another caveat is that there is an insatiable demand for very short money-market securities which depresses yield, too. Money market funds in particular whose assets have increased by over $17 billion so far this year are finding the supply of short-term securities is less than demand. Banks, for instance, have not been issuing certificates of deposit due to the decline in their loans.
The conclusion to be drawn from all of the above would seem to be that there will be no recession, credit demands will remain strong, inflation will not decline, the administration's economic plan will be in limbo for several months and long rates will remain high. Consequently, and due to all the uncertainties most investors want to stay in short investments to protect their principal and to earn a hefty return as well. And this seems to explain why short rates are falling and long rates are staying at recent high levels.
This week three large general obligation issues will be offered by New York, Illinois and Louisana. Because banks have not been buying short maturities now, prices could result in attractive yields in the one-to-five-year area.
The Treasury will offer a two-year note on Tuesday. The issue will come in minimums of $5,000. The Treasury also will offer a 62-month note on Thursday in minimums of $1,000. If the issues were to come today, the two-year would return 13.7 percent and the five-year, 13 percent.