An unusual phenomenon has decended upon the various sectors of the bond market that has made it rather difficult for the market to improve.
The phenomenon is the glut of secondary market issues in the government, corporate, municipal, Eurobond and even money market areas of the fixed-income market. Secondary securities are issues that have been around for a while, or "seasoned" for a period of time. Primary issues are new, or "fresh," issues that are being offered in the marketplace.
Such occurrences in the market are referred to as technical factors because they are usually short-term in nature and correct themselves rather quickly.
This technical situation has been caused by several factors. Heavy supply, aggressive bidding by underwriters for new issues, a rapid drop in interest rates and uncertainty about the future direction of the market by investors all have helped to increase the size of the secondary market.
As an example, the number of new issues being brought in the municipal market has broken all records. Most of the new issues may get sold, but quite often various maturities do not get sold and they simply become secondary securities that are advertised in what is called the Blue List. Currently, a record amount of $2.2 billion is being shown in the Blue List.
In the corporate sector, the yield spreads between discount corporates, issues selling below par ($1,000 per bond), and Treasury issues narrowed dramatically. As a result, institutions sold their discount corporates and bought treasuries. With the spreads so narrow, no one was there to buy the corporates from the dealers who are now stuck with the excess merchandise.
In the overseas market, dealers bid too aggressively for the new Eurobond issues and are innundated with unsold bonds, especially since interest rates have risen slightly in recent days.
The story is practically the same in the money market area. A lot of banks have taken advantage of the recent drop in interest rates to borrow funds for one, two or more years by issuing certificates of deposit of that length. Dealers buy the CDs and then resell them to investors. With short rates having backed up, the dealers have been unable to resell the term CDs that they have purchased from the banks.
Finally, the Treasury market is almost a mirror image of the other sectors, except for a slight twist in names. If you were to ask a dealer for quotes on the current new issues, he would give you the most recent two-, three-, four- or five-year issues. These are called "on-the-run" issues.
Older issues that the new "on-the-run" issues have replaced are known as "off-the-run" issues. With the price advances of the past three months, many investors have taken profits in their "off-the-run" issues by selling them to the government dealers. However, in replacing these issues, investors have made heavy purchases of the new "on-the-run" issues, leaving the dealers stuck with significant amounts of "off-the-run" items.
The bottom line is that these secondary positions must be "carried," or financed, by the dealers, which cuts into their ability to underwrite new issues. In effect, the ability of the market to improve is anchored by the large unsold secondary positions of the dealer community. This technical consideration only can help to confuse the issue as to the true direction of interest rates at this time.