Confusion and uncertainty would describe the bond markets last week. Rather than any overall logic to price movements, the markets were controlled by technical factors that it perhaps did not understand and that led to price fluctuations that appeared to have little rationale. On top of that, the uncertain outlook for Federal Reserve policy in the face of rising money supply, and the expected announcement by the Treasury of its new "clustered auction" proved reason enough for retail buyers of Treasuries to withdraw to the sidelines and leave the market to the professional traders and bond dealers.
The Federal Reserve supplied funds to the market on Monday, which was bullish and helped prices advance. Prior to the Treasury's auction announcement, dealers tried to set up short positions -- selling issues they didn't own, borrowing that issue to make delivery, and hoping later to buy the issue they had sold at a lower price, and at a profit. But advancing prices forced the dealers to incur losses by purchasing at higher prices the issues they had sold short.
On Wednesday, much to everyone's surprise, the Fed drained money from the banking system, which caused prices to decline. Did the Fed know something the market did not? Perhaps the Fed knew that the money supply growth would be unusually large over the next two weeks and was taking steps to meet that situation?
Again, confusion and doubts and more uncertainty, even though the Treasury's auction announcement was just as the market had expected. On Thursday, the Fed added funds to the banking system, which helped prices rise, but someone had a short position in the long Treasury and was unable to buy in or cover their short position. Consequently, that issue led the markets advance the rest of the week as the "short" scurried about trying to buy in the long bond. And so the market moves went, and all for technical reasons.
In the face of such turmoil, short-term money market instruments have been relatively stable over the past few weeks. Surprisingly, in the face of the Manville Corp. filing a Chapter 11 reorganization a few weeks ago, the various quality yields spreads between commercial paper issuers has remained unchanged. The spread between A1/P1 and A2/P2 paper has hovered around 100 basis points since early summer, having widened from 50 to 75 basis points in the spring. More surprising is the fact that this spread was as wide as 200 basis points in 1980, before all of the bankruptcies and problems with the financial institutions.
The market will be dominated this week by the U.S. Treasury, which will sell $22.9 billion of securities in four days; $11.2 billion represents new money. On Monday, the weekly three- and six-month T-bills will be sold. On Tuesday, a four-year note, on Wednesday, a seven-year note and on Thursday, a 20-year bond will be offered. The three coupon issues represent the Treasury's new "clustered auction," which it hopes will help focus investors' attention on the three issues at one time. It will also allow the dealers a longer period of time to distribute these issues before they must be paid for. All three issues will be available in minimums of $1,000. The two notes will come in bearer form with coupons attached, while the 20-year bond will be sold in book entry form -- no physical delivery -- or in registered form. The four year should return around 12.40 percent, the seven-year 12.45 percent, and the long bond 12.25 percent.
Individuals may obtain these issues by entering noncompetitive bids prior to the sales, at the U. S. Treasury building, or at any of the Federal Reserve banks or their branches. Investors may also purchase these issues through their brokers, or their banks, but at a fee.