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May 6, 1988
As this letter is written, early Friday morning, the bond market is having a bad time, and mortgage rates are up about a half in discount since the end of last week.
Though the Fed did not appear to tighten this week, this morning's Unemployment report was about as bad for interest rates as possible, showing a decline of .2% for the month to 5.4% of the workforce. The jobs data could have been worse, as NonFarm Payroll grew by only 174,000, but February and March were both revised upward. The bond market's trouble with these numbers rests on the theory that increasing employment signals a strong economy, and inflationary wage increases occur when there is too much competition for scarce labor. Other economic data released this week showed Factory Orders up 1.6%, Construction spending up 1.5%, and a string of disturbing upward revisions in data released earlier in the year.
The big deal next week is the Treasury's threeday borrowing extravaganza, which happens once each quarter of the year, hence known as the "Quarterly Refunding." On Tuesday, Wednesday, and Thursday next week, the Treasury will auction $26 billion in 3year, 10year, and 30year obligations; of the total, $9.5 billion will be new cash.
The Treasury auctions all of this debt to the Primary Dealers (36 or so big securities firms and banks no other entity or person can bid competitively) who sell the bonds to the rest of us later. It is not an accident that the bond market has a bad time going in to each refunding, and tends to rally afterwards. The dealers want to buy the bonds as cheaply as possible, and sell them later at the highest possible price. The Fed tends not to monkey around with interest rates during this process (it is not a good idea to create a disorderly market while trying to sell $26 billion of your own bonds).
So, even though the Fed seems likely to tighten before May is over, we may get a breather for a couple of weeks, and even see a small decline in mortgage rates by late next week. This is still not a market on which to bet a deal; if the auctions do not go well, we can have a nasty time.
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