Everyone agrees the bond markets want to do better, but several obstacles have kept this from occurring. By all rights, interest rates should be declining. Inflation is falling, the economy remains extremely soft, which should bring about a reduction in the demand for money.

However, the rise in the money supply over the past several weeks has market participants scared and buffaloed. The federal funds rate, the rate at which member banks of the Federal Reserve System lend their excess reserves to each other and the rate that depicts the amount of restraint or ease within the banking system, has been rising steadily since the beginning of December. This rise has paralleled the growth of the monetary aggregates and has led many to believe that the Fed is actually tightening credit. The paradox is that the monetary aggregates usually grow with a growing economy. Now the economy is soft, yet the aggregates have grown strongly. This confusion has hurt the market.

But to the person dealing daily in the government market, the most complex issue has been the Fed itself. When the banking system is short of reserves, the federal funds rate will rise. When the system is awash in reserves, the funds rate will decline. The Fed can influence either situation by adding or subtracting reserves through "open market operations." If reserves are needed, the Fed will supply reserves by doing "repos" with dealers. To subtract reserves, the Fed will do "reserves repos" with dealers. Last week the Fed not only did both, but did them on the same day. Although there are certainly technical considerations, market participants literally did not know which way to go. As one confused trader said, "this isn't a market for women and children."

On top of this, a huge quarterly Treasury refunding will be announced this Wednesday. The magnitude is estimated to be between $9 billion and $9.5 billion. With this hanging over the market, it's extremely hard to persuade retail buyers that now is the time to be buying. More will be written next week on this important refunding.

Investors should take note of a Student Loan Marketing Association issue (Sallie Mae) to be offered this week. This issue will be a three-year, floating-rate note whose interest will be set weekly and paid quarterly. The weekly interest will be based on a fixed spread (75 basis points) above the corporate equivalent of the average return on the weekly 90-day Treasury bill auction.

The Sallie Mae's will come in minimums of $10,000. In a period of falling short-term interest rates, these notes should perform well. Sallie Mae's are agency paper and the student loans behind the issue are backed either by government insurance or state guaranteed paper, which is reinsured by the government. Merrill Lynch is the only retail underwriter in this issue.

While the domestic corporate market has only witnessed the sale of a couple of issues this month, the Eurodollar bond market is being flooded with zero coupon issues (zero coupons are like a long-term Treasury bill -- no coupon). Over $2 billion in face amounts are currently being sold by U.S. companies abroad. It is not only cheaper for the issuers to market their bonds abroad, but they have been eagerly sought by Japanese investors because of the large tax benefit resulting from the deep discount.