Just a few random thoughts on the dramatic decline in the Treasury bond market. Once again, it becomes apparent how sensitive our markets are to outside factors. International events played a big role in the bond price declines. As oil prices began to rise in the cash and futures markets, inflationary fears permeated the marketplace and helped to push prices lower. After all, if falling oil prices mean lower prices, rising oil prices should lead to higher prices. Added to this key factor was the continued decline of the dollar in the foreign exchange market.
This week, the Treasury will announce a blockbuster refunding of about $24 billion. During the past 18 months, the Japanese have purchased about 25 percent of our 10-year, 20-year and 30-year issues. Concern arose that the devalution of the dollar might keep the Japanese interest in this record refunding at a minimum. And if that were true, then who would step in and pick up the slack? This uncertainty placed added pressures on the Treasuries market.
Lastly, the spectacular rise in a Treasury market that has outpaced all other fixed-income markets in price appreciation during the last quarter was ripe for profit taking. As all of these factors came together, they seemed to overlook the apparent weakness in the economy, and Treasury prices simply tumbled. A week ago, analysts anticipated that the average return on the new 2-year Treasury note would be about 6.35 percent. It actually came at 6.68 percent. The 30-year T bond dropped about 4 1/2 points in two days, or $45 per $1,000 bond.
Another intriguing puzzle revolves around the other fixed-income markets: the corporate, the municipal and the mortgage-backed markets. The Treasury market had far outpaced these markets in price advancement, which meant that munis and corporates were "cheap" when compared with the Treasury market. In the decline of the Treasury market, the prices of the other markets did not keep pace with the declining Treasuries. As a result, the other markets no longer are as "cheap" or attractive as they were prior to the selloff. The key question now is whether the other markets will be forced to decline more steeply in price to make them more attractive, or whether buyers will accept them as they are now with slightly higher returns.
What will oil prices do? Will the weak economic fundamentals lead to a renewed rally or has the market turned? These are questions that need answering. The next two weeks should be very interesting, and buyers should wait to see how the markets finally shape up.