The direction of the bond market and interest rates this past week was initially set Friday, Feb. 12. The bond markets were closed that day, but the Federal Reserve announced late that afternoon that the monetary aggregate, M-1, had risen $2.3 billion for the week ended Feb. 3. This meant that M-1 -- which represents the total currency, travelers checks, demand deposits and other checkable deposits in the hands of the public that may be used for spending -- had risen at an annual rate of 20.7 percent in January. The Fed had targeted the growth of this aggregate to be no more than 5 1/2 percent during all of 1982.
The Federal Reserve and the monetarists contend there has been too much money, or liquidity, in the system and that has caused prices to increase, which is another description of inflation. The Fed, in an effort to curtail inflation, has set certain growth targets on the money supply in order to wring the excess money and inflation from the economy. Clearly, this strong growth of M-1 so far in 1982 has been way beyond the Fed's stated top target levels and has raised fears in the marketplace of a more restrictive monetary policy, which entails higher interest rates.
With that in mind, the fixed income markets opened Tuesday as if they had fallen through a trap door. Prices fell and yields soared on all instruments. The long Treasury bond fell at least two points. Yields on some money market instruments rose by at least 100 basis points. As the day wore on dealers who had sold issues short, with the hope of buying them back at lower costs, began to cover their short positions. Since there were relatively few issues around, prices began to rise quickly and much of the loss was regained.
Poor economic news followed during the week. Although bad for eveyone else, this type of news is bullish for fixed-income securities because it means that a sick economy will have need for less credit.
As investors thought about Chairman Volcker's recent testimony concerning the rise in M-1, that these were probably technical increases and would soon "wash out," a bullish feeling crept into the marketplace. Issues rallied and posted sizeable gains for the week. Fed operations supplied liquidity to the banking system that helped short-term rates fall 50 or more basis points on Thursday. What it all boiled down to was that the marketplace was betting on a sizeable decline of the money supply figure in advance of its Friday afternoon release.
And this week, the market won big, as long Treasuries gained over 6 points for the week.
Through all this volatility, the Treasury managed to sell $15.25 billion of Treasury bills and $5.25 billion of two-year notes. One agency sold $1.7 billion of new issues.
Away from the Treasuries activity, few municipals and corporates were sold. This week the Treasury will offer a 5-year, 2-month note, in minimums of $1,000. The Federal Farm Credit Agency will offer three issues on Tuesday. The municipal area will offer two high-grade issues, the state of Illinois and Richmond, Va. Quite possibly a $590 million Austin, Tex., revenue refunding issue may sell. Also, three or more corporate deals may be offered.
The market's bullish sentiments stem from thoughts of a deteriorating economy, lessening demand for credit and a declining money supply. The bears feel the economy has bottomed out, that the growth in the money supply is real and that the Fed eventually will have to restrain credit with higher interest rates. Gone, at least temporarily, is the market's concern over the budget deficits. That battle has yet to be fought.