The market was jolted on Thursday by the report in The Washington Post concerning the impending tightening of credit by the Federal Reserve following this week's Federal Open Market Committee meeting. The FOMC sets the Fed's monetary policy.
Prices on government bonds dropped like a stone, and short-term rates, especially T-bills, rose quickly. As one dealer said, "the Fed might as well had gone ahead and tightened this morning." He added that the government-dealer community had been hurt recently, as it had been unable to resell many of the recent Treasury auctions to retail buyers. This has become obvious as there has been so little bounce to the market lately.
If the Fed acts as expected, then short-term rates should be rising over the next few months. Longer rates should rise initially, but probably due more to uncertainty and to the heavy Treasury calendar. In time, if the Fed's play works, any inflation threat will be slowed, and the accelerating economy will be better contained so that long-term rates should decline.
Currently, a one- to five-year maturity schedule will best serve individual investors. The Treasury will have an extremely large amount of securities to sell during the last half of 1983, and most of them will be coupon issues. This should help increase rates in the one- to five-year area.
A tax-exempt product that has been gaining in popularity, especially in view of the problems with the Washington Public Power Supply System, is the insured muni (municipal) bond funds. During the first half of 1983, sales of insured unit trusts rose to $1.82 billion versus about $1 billion during the same period in 1982.
Along with the insured funds, state bond funds are growing rapidly. These state funds are comprised of various issues of local and state names within a particular state. As such, the income from the fund is completely tax-free for the residents of that particular state. To be attractive to investors, the funds must be issued in states that have high state and local taxes, plus they must issue many securities to allow diversification. Funds have been issued for the states of California, Florida, Michigan, Minnesota, New Jersey, New York, Ohio and Pennsylvania.