The good ship "Bond Market" was buffeted by conflicting winds this past week. During the first two days, little activity was recorded. On Wednesday, good retail buying pushed prices higher, at least until Thursday morning, when a very strong retail sales number forced prices lower.
Right away, investors reasoned that the economy was stronger than most people had realized. When the monetary aggregate M1 was released late Thursday and was down an unexpected $7.1 billion, the market regained a portion of its losses.
The truth of the matter is that no one has a clue as to what is happening. The buyers would like to close their books for the year, while the dealers would like to take their profits or at least limit their losses for the year. No one really knows how strong the economy is, and most analysts felt that M1 would be accelerating in December and not experiencing such a horrendous decline. Other analysts say the economy is weak because we have had a warm fall and consumers have not been motivated to begin their Christmas shopping.
The confusion is so rampant that the dealers don't know whether to buy or sell bonds. Even the talk of possible tax reform has put a cloud over the markets. Probably everyone wishes the curtain would be wrung down for 1984, giving investors and dealers two weeks to forget about bonds and to enjoy the holidays.
At any rate, questions have been asked about the Treasury's tax reform proposal. Should the treasury's proposal become law, Jan. 1, 1986, would be the effevctive date for the proposed changes. What would be vastly curtailed are the "private activity" types of bonds, mainly the industrial development bonds such as student loan issues. The proposal also would do away with certain types of tax shelters and partnerships, which could create interest in tax-exempts. Most important, the proposed changes would no affect the tax-exempt treatment of existing tax-exempt bonds.
Currently, the long-term municipal market seems to have adjusted to any lowering of taxes. For example, the ratio of AAA-rated general obligation yields to comparable 10-, 20- and 30-year Treasuries are 0.72, 0.81, and 0.83, respectively. However, similar ratios in the one-year and five-year maturities are 0.59 and 0.65. In other words, the short-term sector has not adjusted to the proposed tax changes, and that area of the market could be vulnerable to further price and yield adjustments.
The Treasury will offer a two-year note on Wednesday that will come in minimums of $5,000 and should return 10.20 percent.