It has become almost impossible to follow the bond market or to make any sense out of the events that affect that market. Right now there are four major factors that have a direct bearing on fixed-income securities--monetary policy, fiscal policy, federal budget deficits and the economy. All are interrelated and perplexing in the signals they are giving investors.
As a result, it is extremely hard to understand what is happening. Take monetary policy. Until last fall, the Federal Reserve had mainly used the monetary aggregate M1 on which to key its policy. Then M1 began to grow as the All Saver certificates started to mature, with the proceeds being placed in bank accounts that fell under the M1 aggregate. At that time, the Fed said the broader aggregates, M2 and M3, would be used in setting policy.
In December, the new money-market deposit accounts were initiated at commercial banks and thrifts. These accounts came under the M2 aggregate, which grew very quickly.
On Feb. 14, the Fed revised its monetary figures to take into account annual seasonal adjustments and benchmark changes. It also redefined M2 and M3 to reflect other changes.
Two days later, Fed Chairman Paul A. Volker told the Senate Banking Committee that the broader measures would continue to be the aggregates the Fed would key on. He also widened the target range for M2, and said that an average number from February and March would be used as a new base to track M2, instead of the end-of-the-year base number, as in M1 and M3. The changes were designed to mollify the huge jump in M2 during January.
Were those moves logical? Perhaps, but they definitely were extremely confusing. As the chairman's statements were released, the market didn't know which direction to go. Bonds rallied in New York and declined in London.
Next, try to fathom the direction of fiscal policy. Huge deficits are resulting from a structural imbalance between federal outlays and revenues. So the questions arise: Will Congress reduce the defense sector? Will the entitlements and the social sector be affected? And will taxes be raised?
Finally, there is the economy itself. Bedraggled and weak, it is attempting its third recovery in three years. Just last week, various economists stated that the recovery will be weak, moderate, unusually strong or will go nowhere after the first half of 1983. The current economic numbers are mixed, which is to be expected at this time. But, is a recovery underway or not?
In sifting through these pieces of confusing data, it would appear that a fragile recovery is underway and that the Fed does not wish to abort the recovery by raising interest rates. Instead, the Fed, with it's hocus-pocus monetary policy, will be accommodative until the recovery becomes well entrenched. In the meantime, the budget situation will also affect interest rates.
In this murky atmosphere, the Treasury will sell $5.5 billion 5-year notes Wednesday in minimum denominations of $1,000. They should return around 10.10 percent.