A decided change in bond market psychology occurred last week. The previous feeling of an imminent move to lower interest rates evaporated into a new feeling that interest rates have seen their lows for now. All sectors of the market suffered as prices tumbled and interest rates rose in all maturities.
The main causes for this metamorphosis was a change in some fundamental conditions, and in several technical aspects of the market. From the fundamental standpoint, everyone had been talking about a fragile economic recovery that was in danger of being aborted by the still remaining high interest rates. But for the past several weeks, the economic data has been strong, while the growth of inflation has been negligible.
Further, the growth in the money supply, especially M1, fell during the month of April. This factor plus the rapid decline in inflation helped the markets catch fire, and investors felt that the discount rate would quickly be cut by the Federal Reserve and long Treasuries would soon be yielding 9.5 percent.
However, a funny thing happened before this hopeful scenario became fact. Two weeks of large monetary growth and too much volume choked off the rally and sent the investors back to their crystal balls. First came the $15 billion Treasury refunding and then $2.7 billion of corporate issues that surprisingly came to the market concurrently with the Treasuries. Prices on several corporate issues were set too aggressively and a logjam ensued.
At the same time, a large supply of new municipals began to roll on the market and we were soon awash with unsold bonds. With the good economic data arriving daily, investors felt that renewed credit demands would surface from the private sector. Putting it all together -- a better economy, a growing money supply, increased credit demands, a heavy municipal calendar and the always present and immense Treasury needs -- the market decided that higher rates would be needed to entice investors to purchase debt securities.
Price adjustments were necessary in many of the new municipal issues. In the past two weeks, the returns on 30-year revenue issues have risen 3/4 of a percentage point. The equivalent price change is around 7 points. Five-year maturity yields have increased 25 to 40 basis points, while 10-year yields are up 50 to 60 basis points.
Congress, it's hoped, is about to approve the increase in the debt ceiling before May 31 so that the Treasury may go on financing the government needs. On Tuesday the Treasury will sell two-year notes in minimums of $5,000, while on Wednesday they will offer a five-year, two-month note in minimum denominations of $1,000. They should return 9.75 percent and 10.30 percent respectively.