Technical factors kept the Treasury market off balance during the final week of the year. The usual year-end demand for cash by corporations, plus the need by dealers to hold and to finance recently issued Treasuries, forced the cost of overnight money above 9 percent. That pressured other money market rates to rise, causing slight price declines in the coupon area. As dealers reduce their positions, that the situation is expected to correct itself and short-rates will decline once again.
We enter 1983 with the bond markets on solid footing and facing another year of heavy financings. It is highly unlikely that the dramatic swings in interest rates that occured in 1982 will occur in 1983. Inflation has declined to a 4 to 5 percent level and, with a little luck, could hover around the 3 to 4 percent level in 1983. Therefore, unless inflationary expectations are dramatically rekindled, interest rates should not move much higher than current year-end levels.
In fact, there are only a few situations that could push interest rates higher. They are: continuous monetary expansion, which would arouse inflationary expectations; monetization of the debt by the Federal Reserve, which would likewise be inflationary, and a strong recovery. A strong recovery would require a major pickup in both business inventory buying and a major increase in consumer spending. Should this happen, a dramatic increase in the demand for short-term funds would take place, which would cause short-term rates to rise.
On other hand, if interest rates were to rise 50 to 100 basis points from current levels, any chance of a recovery would be aborted, which could possibly lead to a depression and eventually much lower interest rates.
1983 will be filled with potential problems. Sam Nakagama, Kidder Peabody's chief economist, writes that "the world is in a race between reflation and depression." He warns that, unless the industrialized nations begin a real economic recovery soon, "the international financial structure may prove unable to withstand the strains imposed by the forces of deflation, default, and illiquidity." Fears of a rapid decline in oil prices are beginning to be a major concern. The Treasury will have to finance the largest federal budget deficit ever, which could keep the lid on any real recovery. However, Congress will continue to pressure the Federal Reserve to push rates lower. The pitfalls seems endless, and the options relatively few. In spite of all these potential dangers, fixed income securities would benefit the most should any of these events occur, except for an increase in inflationary expectations.
In this atmosphere, investors will be treated to the largest supply of new Treasuries ever marketed. The municipal volume should remain high, but nowhere near the record $75 billion of new long-term bonds sold in 1982. The corporate volume could be sizable if interest rates stay at current levels or move lower. By and large it should be an interesting year, and investors would be wise to stay with quality issues. And as the sergeant on Hill Street Blues admonishes at roll call, "Heah, Let's be careful out there!"