The fixed-income market was striken with a "boredom fit" last week. Perhaps the holiday-shortened week helped turn events into a ho-hum situation.
In effect, the markets are extremely lethargic and are not responding as you would expect to either bullish or bearish news. The classic situation is evolving that would dictate a decline in rates. The federal funds rate has fallen nicely; the cost for dealers to carry their inventory is now beneficial to them; the economy is still drifting lower; money supply, as recently commented on by Fed Chairman Paul A. Volcker, is manageable, and the inflation outlook continues to be rosy. In spite of these favorable points, the bond market retreated and gave up most of its hard-earned price gains to recent weeks.
One government dealer commented that this unexpected opposite reaction of interest rates to bullish news has the potential for hurting many people. He points out that given the bullish facts mentioned above, dealers have increased their inventories of bonds in expectations of higher prices and lower interest rates. But as prices continue to slide lower and rates rise, the dealers begin to suffer losses in their positions. This may force them to start dumping their bonds in an effort to try and cut their losses as best they can. With no retail support for the market, and the beginning of heavy Treasury financing this could lead to a real blood-letting.
This particular dealer made one other ominous point, which was that it was becoming more difficult to operate in the market, as the market was becoming illiquid. He felt that past yield and price spreads between various bonds were breaking down and consequently it was becoming more difficult to figure where one bond should trade against another. Further, there are a lot more players involved now, they operate in enormous size and carry hedged positions in the futures market. The recent Drydale debacle also makes it harder for the dealer to carry their positions and necessitates the need for greater capital in a government-bond operation. The bottom line is that more problems are created for the dealers in doing business, which in turn helps sap the liquidity from the market.
Perhaps another reason for the ho-hum attitude is the fact that the market has been bombarded with so much news and views for the past 18 months that the players have simply turned a deaf ear to all the verbiage.
Certainly the most subversive element facing the market is the lack of federal budget dialogue and the expectation that nothing worth while will occur until after the election. In the meantime, the wave of new Treasury financings is about to break over the marketplace and probably scuttle any chance for a continued upward price movement. However, the weakness being shown by the economy could seriously impair any real recovery in the third quarter, which could help bond prices. But this bodes ill for the stock market, especially since after tax profits fell 30 percent during the first quarter and profits would show little improvement for the rest of 1982.
LPrices on recent municipal issues, Washington Public Power, State of Wisconsin and New York State TRANS, were lowered in order to facilitate the sales of these issues. Some of the TRANS, which were due in March of 1983 and originally returned 8 percent, are now yielding 8.75 percent. This overhang of the huge short-term TRANS issue has helped to keep short-term, tax-exempt yields high while taxable short yields have fallen. Consequently, tax-exempt money market funds are now more attractive to investors in the 50 percent bracket than are the taxable money market funds. Rowe Price's tax-exempt fund is returning 7.72 percent, while the after-tax return on the taxable fund is 6.95 percent (13.90 percent times 0.50) an after tax advantage for the taxexempt fund of 77 basis points. This spread is unusally wide.
On Tuesday $2 billion short-term government-backed project notes will be sold. The bulk of the issue will mature in November, December and January and should return 7 3/4 to 8 percent. The State of Maryland will offer $140 million of triple-A rated general obligation bonds on Wednesday.