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HIGHER RATES FOR NOW
Prepared by MCM, Inc.
(May 19, 2000) The most important economic data due in May have now been released and the Fed's policy stance for the next 6 weeks is public knowledge. The US debt market will thus turn its attention to other issues, with the Fed and the data still firmly in mind. Among the factors shaping interest rates over the next couple of weeks will be the rise in new issuance of corporate debt and the indications of coming debt market weakness that market technicians are seeing.
Corporations and investment bankers appear to believe that interest rates will be rising in the medium term and that it would be prudent to meet funding needs for the next quarter before the Fed has a chance to raise rates again. That and a pick-up in mergers have boosted issuance. The environment for issuance is tough, but not entirely unfavorable. Profits are strong, which should make investors less cautious of buying new corporate debt. Investment bankers, however, still face the burden of tailoring the issues to the market interest. In some cases this means smaller deals and in some adjusting maturities to investors' liking.
After an April drought, new corporate debt issuance picked up this week, including pricing of the long awaited $2.5 billion Phillips Petroleum and the huge $5 bln WorldCom four-part deal. (See chart at left for these trends.) More moderate issues are on tap for next week.
Market technicians see the coming period as risky for a wide range of debt types and maturities. In particular, 30-year Treasury bond yields are pressuring the recent yield high near 6.25%. Any rise past that point is likely to mean a further rise to near 6.34%. As of this writing, two-year Treasury note yields are nearing 7%. With $10 billion in 2-year Treasury notes to be auctioned on Wednesday, there is a chance 7% will be reached, a development which technicians expect will lead to 7.2% 2-year rates, perhaps even 7.25%. A similarly bearish technical picture is seen for debt from quasi-governmental agencies such as Fannie Mae and Freddie Mac.
This view of rising rates is consistent with the message of the FOMC's policy announcement on May 16, which was rather worried in tone. Premonitions of higher Fed rates can also be had from statements of Fed officials, including those from typically dovish New York Fed President McDonough this week.
There is perhaps one saving grace in this outlook. The dollar has been storming higher against most European currencies and holding its own until Friday against the yen. All US financial markets may see stronger foreign interest if dollar strength persists. The yen may weaken as well, should Japan's fragile economy begin to disappoint investors. This more upbeat view actually fits well with the slightly longer term technical outlook: it is for a near term rise in rates which sets up another push lower in rates in the medium term. Dollar strength could be the catalyst which brings lower yields.
May 19, 2000 MCM, Inc. 294 Washington Street, Ste. 734, Boston, Massachusetts 617-338-9219
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