Gotcha! That's what the market is saying to bond professionals. Once again the market was caught napping, lulled into a complacency about the economy and the market's direction.
In projecting the outlook for rates, two camps have evolved. One saw a weak economy coming out of hibernation and growing strong in the second quarter of the year. Interest rates would move higher in the summer and, in time, choke off economic expansion. As the economy slowed, interest rates would begin to move lower.
The other camp believed that the economy already was hurting and that real economic growth would continue below the 4 percent growth projected by the administration. With this scenario, the Federal Reserve would not tighten credit even if money supply growth continued above the Fed's targets, and in time, interest rates would decline.
The great majority of investors disagreed with the second view. The economic data released in the latter part of March, although not robust, seemed to encourage expectations for a "strengthening economy." But April's data has been just the opposite, showing weakness.
So when Chairman Paul A. Volcker of the Federal Reserve mentioned the weakness of the economy and questioned its sustainability in a speech Tuesday, the market was jolted and sat upright. On Thursday, when retail sales were found to be down 1.9 percent in March, the market realized Volcker's concern, especially because consumer spending represents 60 percent of the gross national product. While the market tries to discern where the economy is headed, prices have risen anywhere from one-half to 2 points over the week.
Couple those facts with the federal budget compromise of two weeks ago and a bullish scenario is warranted. However, even though the budget plan has been drawn up in the Senate, the war has yet to be fought and the actual cuts may be decidedly different from what has been hoped for. Again, like the economy, nothing is certain.
The municipal market has been undergoing a rally for two weeks. A good portion of the dealers' bond inventory has been purchased, and the new issues have been well received. In fact, the dealers' inventory has declined by half a billion dollars since March 22. Good buying interest has pushed yields lower by 50 to 75 basis points [one basis point equals a hundredth of a percent] in maturities ranging from 10 to 30 years.
With no real Treasury financing until May and with the growth in money supply expected to slow in April, we may have a few more weeks of a good market and a better fix on the health of the economy.