There are four factors that are adversely affecting the bond market at this time. The first is the rapid growth of the monetary aggregate M1, which is some $15 billion above its upper target level. Next is the fear that the Federal Reserve will have to respond to this growth and tighten credit to the point where interest rates will rise. In fact, everyone admits that the M1 growth is much too rapid, and that the Fed will have to tighten, but the query is, when will the Fed tighten and by how much? This uncertainty has led the Treasury market into an oversold position.
The other two factors that cast gloom over the markets are the massive federal financing needs plus the apparent strong growth in the economy. The latter should lead to an increase in the financial needs of the private sector, and analysts fear that these increased needs will collide with the insatiable needs of the federal government. Taken together, these two forces could push interest rates higher..
When the federal funds rate, which measures the amount of ease or tightness in the banking system, moved above 9 percent, the market gave ground. However, technical reasons probably played a part in that move, so as yet, no real confirmation exists to the Fed's intentions.
Despite a lack of certainty, the markets have undergone great price and interest rate adjustments. The long Treasury bond has moved from 10.26 percent in early May, to 10.95 percent last week. The returns on the three-month Treasury bill have risen about 70 basis points during the same period.
But the largest adjustments have occurred in the tax-exempt market. The returns on long single A revenue bonds have risen over 125 basis points. In fact, some returns on single A revenues last week were in the 10.50 percent to 10.75 percent range. Two factors led to the municipal market adjusting so much more than the government market. First, a large supply is being dropped on the market by issuers who are trying to beat the July 1 date, when all new issues must be issued in registered form.
Second is the Washington Public Power System debacle. Both Moody's and Standard and Poors credit rating agencies have withdrawn their Investment Grade ratings on the bonds of all five of the projects. Because the $8.3 billion of outstanding WPPSS bonds are now without Investment Grade credit ratings, many holders of these bonds, for fiduciary reasons, may be forced to sell their holdings. A legitimate question, of course, would be to sell to whom? By Wednesday, the low coupon bonds of projects No. 1 and No. 3 were selling in the 14 percent to 15 percent range, while similar bonds of projects No. 4 and No. 5 were in the 27 percent to 30 percent range. But count your blessings; WPPSS seriously considered building projects No. 6 and No. 7.
On Tuesday, $1.7 billion of government-backed project notes will be sold. These prime tax exempts will mature monthly from October of 1983 through July of 1984. They should return from 5.10 percent to 5.50 percent. With the municipal market so depressed, attractive buying opportunities are available.