The strength of the bond market amazed both dealers and investors this past week, especially in the face of $22.9 billion of Treasuries that had to be sold, and the announcement on Sept. 17 of the continued growth in the money supply. Prior to last Monday, the general feeling was that the large volume of Treasury financing and the growing money supply would cause interest rates to move to higher levels.
But this scenario never panned out. On the 17th, the markets showed that they had expected the new four-year Treasury note to return 12.40 percent, the seven-year note 12.45 percent and the 20-year bond 12.25 percent. In actuality, these issues came with average returns of 12.30 percent, 11.94 percent and 11.68 percent, respectively. Dealers say that there was a sizable retail buying of the new Treasury issues. Obviously, something has changed, and that something is the psychology of the investor.
The marketplace now feels that the Federal Reserve has few options in dealing with interest rates. The Fed cannot allow them to rise. In looking at the United States, investors conclude that an anemic economy, beset with low productivity, high unemployment and rampant bankruptcies, can ill afford to see interest rates rise above current levels. On top of that, the Treasury would hate to see rates move to higher levels that in turn would increase their financing costs and ultimately increase the deficits themselves.
Finally, the worldwide banking system remains in fragile condition. International banks are saddled with billions of dollars of nonperforming or non-interest-earning loans made mainly to Third World nations whose economies are mired in recessions along with the economies of the industrialized nations. Higher interest rates would create more havoc with the international banking community.
Armed with this rationale, investors who had missed the recent rally, along with investors who witnessed the rates on money market funds drop to 9.5 percent and T-bill rates fall to 8 percent, began to extend their maturities and buy longer securities with rates of 12 percent or more.
Corporations viewed the falling rates with delight and quickly marketed over a billion dollars worth of their issues in spite of the large Treasury financings. Right now, the crowding-out theory, which holds that the Treasury and private borrowers would be unable to finance heavily at the same time, has been laid to rest. So far this year, corporations have sold a principal amount of $28.6 billion, up 11 percent over last year's financings of $25.8 billion during the similar period.
This figure would be much larger if it were not for the Euro-bond market, which is centered in London. That market had, until this year, mainly attracted U.S. corporate issuers with BAA and A ratings. But the recent financial problems of the international banking community has made the European buyers desirous of AAA- and AA-quality American paper.
Consequently, high-quality U.S. firms have been able to finance in the Euro-market with at least half a point savings in interest, as opposed to financing domestically. So far in 1982, $37 billion of new issues have been sold in the Euro-bond market versus $19.8 billion over the similar period in 1981.