Both administered and market interest rates continued to fall as more ugly economic news was released. A sizeable decline in durable goods orders showed that the economic malaise was widespread. A bright spot was the consumers price index, one yardstick of inflation, which was only up four-tenths of one percent during October. However, anyone shopping for Thanksgiving would question the modest rise in the C.P.I. index.
Short and long rates continued downward although the rate declines hiccupped at times. Further declines depend on overt Federal Reserve action to reduce rates, which in turn will focus on the direction of the economy. Although rates have declined dramatically and over a relatively short period of time, further rate declines will be obtained grudgingly.
During the three-month span of the second quarter of 1980, short interest rates, as measured by the federal funds rate, declined around 1,000 basis points and long Treasuries fell about 310 basis points. Currently federal funds have declined around 675 basis points, but over a five-month period. Long Treasuries have dropped 210 basis points, but that has been only over the past two months. The longer rates have declined more slowly, undoubtedly out of concern over heavy financings and large budget deficits.
For the time being, investors have forgotten about their fears of the large deficits which now seem certain in 1982. A soggy economy and declining rates have taken center stage. The calendar is a major concern and all three bond sectors will be swamped periodically by new issues.
The municipal market will face an unusually large calendar for the rest of the year. At least $1 billion in power authority bonds plus $1-2 billion in single-family housing mortgage issues are scheduled to be marketed. Certain legal limitations were relaxed on the mortgage bonds, which brought on the flood of new issues.
The corporate area is likewise faced with a huge supply. An upward moving Treasury market has helped break log jams in the corporate market on several occasions. But even the Treasury market needs help from the Federal Reserve to maintain its momentum. If the Fed should step back and rates begin to rise, the markets would collapse.
The question is, where will the markets go from here? If the economy continues to deteriorate, rates will move much lower. Should the Jan. 1 tax cuts plus increased defense spending and lower interest rates all prove beneficial, the economy could recover quickly. If this should happen the move to lower interest rates would end in a second.
Investors who are extremely bullish on bonds (believing in a full-blown recession and continued ease in monetary policy) should buy long corporates with high coupons. Yields on money market funds will continue to lag behind the rate decline in money market instruments. This accounts for the $5 billion growth in these funds during the last two weeks. Eventually rates on these funds could settle around 10 percent. In timing a swing back to higher rates, investors could consider six- to nine-month certificates of deposit at thrift institutions that are currently returning 11.75 percent. Lebherz has 21 years' experience in fixed-income investments.