SMITH BARNEY SHEARSON ECONOMIC AND MONETARY TRENDS Two short stories Mitchell J. Held 1 U.S. Securities.. Who's Buying 'Em? Much has been written over the past few quarters about U.S. residents' appetite for foreign securities. Foreign investors have not given up on U.S. securities either. Foreign investors purchased $27.9 billion of Treasury notes and bonds during the third quarter of 1994 (67% of new supply), more than they did in all of 1993 . Central banks remained steady buyers, probably a function of foreign exchange market intervention. But after selling $11.3 billion in the second quarter, private investors purchased 59.7 billion of notes and bonds in the third quarter. Data by country/region do not separate official from private sector transactions, so a complete analysis of private-sector flow is difficult. Yet, investors from Latin America and the Caribbean remain heavy net sellers, liquidating $10.2 billion in the third quarter, after a $15.7 billion net liquidation in the second quarter. Large selling took place for resident investors of the Netherlands Antilles and the British West Indies, suggesting that it was either too hot down there during the summer months or that it could have been the activities of hedge funds. UK. residents purchased nearly $14 billion of Treasury notes and bonds during the third quarter, double the total for all of 1993, bringing European purchases to $17.1 billion. European investors liquidated Treasuries during 1993. Asian investors were buyers of S15.3 billion in the third quarter, bringing total purchases to more than $33 billion in the first nine months of the year. We're assuming that central banks made much of these purchases. Other asset classes saw reasonable buying levels as well from the private sector. More than $5.5 billion of agency paper (including mortgages) was purchased in the third quarter, bringing the total for the year up to $16.3 billion. This is less than one-half of 1993 net purchases but is on track to exceed the $18.3 billion purchased in 1992, the second-highest year on record. Investors bought nearly $1O billion of corporate bonds, bringing the January-September total to $29.4 billion, just shy of the $30.4 billion for all of 1993. And foreign investors were net buyers of $700 million of corporate equities in the third quarter In 1994 through September, foreign investors had purchased $5.8 billion of corporate equities, down from $21.6 billion in 1993. Banks: How Will Loan Growth Be Funded? Throughout 1994, banks have become more generous with their funds. Bank loans rose at a 8.6% rate last year. A cessation of investment purchases and, more recently, some modest liquidation has helped the banking system fund the loan growth. But the funding may be strapped over the next few months. Banks have raised rates an CDs and that has helped increase the growth rate of small time deposits. Indeed, through December, small CDs had grown at a 16.3% annual rate over the past three months and at an 11.7% annual rate over the past six months. But CD growth appears to have come at the expense of lower-cost savings deposits, which have fallen at a 12.8% annual rate over the past three months and 10.2% over the past six months. Indeed, the dollar decline of savings deposits has exceeded the dollar rise of CDs, during a time in which demand deposits and other checkable deposits are declining as well. (Large time deposits have risen at a 20% annual rate over the past three months). In an environment in which the Fed is beginning to restrict liquidity, the only liquidity resource that the banking system has (outside of foreign flows) is investment portfolios. In spite of the market's recent rally, chances are that the bulk of the "held far sale" portfolios remain underwater, making the banks somewhat reluctant to record the loss. In an environment in which the Fed's recent loan officers' survey continues to suggest an easing of the credit quality reins, a legitimate question may be raised about the banking system's ability to continue lending funds at recent growth rates, without significantly raising the relative cost of borrowing to its ultimate customers. This is occurring at a time when consumer debt levels have already become relatively high. TREASURIES Douglas Schindewolf This week, the Treasury sold roughly S77 billion of securities ranging in maturity from 64 days to 30 years -- how's that for variety! The quarterly refunding package accounted for 40 billion of this week's slate of auctions. Considering the fact that there was a considerable run-up in prices in the wake of the employment report at the end of the prior week, the market negotiated the new supply admirably. On balance, the three-month bill rate was about unchanged far the week and the yield on the long bond increased by about five basis points. Yields on intermediate securities rose a bit more -- almost 15 basis points on the two-year note, for instance -- with that sector caught in the throes of the debate about the likelihood of another rate hike from the Fed. In our judgment, so long as the market is caught between the view that the tightening cycle is over and that another rate hike is possible, the two-year/fed funds spread is likely to vacillate within a range of 100 to 150 basis points, implying a 7.0%-7.1i% trading range for the two-year note. If sentiment shifts toward the view that the tightening cycle is over, we would anticipate a contraction of the spread to the 50-to-100 basis point range (6.5%-7.0% for two-year notes). If sentiment shifts toward the view that another rate hike from the Fed is likely, a contraction of the spreads could still occur (on the assumption that this is likely to be the Fed's last move but it would apply to a higher fed funds target (probably 6.5%), implying a continuation of the 7.0%-7.5% range for the two-year note. The quarterly refunding kicked off on Tuesday with the sale of S17 billion three-year notes. This auction drew strong bidding interest, including $1.6 billion noncompetitive tenders, compared with an average of S1.1 billion at the prior six auctions. The bidding produced an average yield of 7.34%, compared with 7.41% at the prior auction last November. The sale of $12 billion 1O-year notes the following day was met by only a lukewarm warm reception and resulted in an average yield of 7.54%, compared with 7.96% at the prior auction last November. The refunding concluded with a well-received sale of $ll billion 30-year bonds on Thursday. The average yield was 7.65%, setting a coupon of 7 5/8% on the new benchmark bond of 02/25. The next auction of long bonds will be in August. Note: beginning with the two-year note auction scheduled far February 22, competitive bids in all note and bond auctions must show the yield bid expressed with three decimals. (Competitive bids in Treasury bill auctions will remain unchanged -- that is, the bid must show the discount rate expressed with two decimal places.) For the record: The minutes from the December 20 FOMC meeting suggest that the jitteriness of the financial markets amid the Orange County fallout and the approach of year end played a secondary but influential role in the Fed's decision not to raise official interest rates at that meeti ng. The following is an excerpt from the minutes: "A number of members commented that financial markets might tend to be a bit unsettled over the balance of the year as a result of the expected year-end adjustments, along with the un certainty about the effects and incidence of the sizable market losses incurred by some investors in 1994. In these circumstances, where there did not appear to be an urgent need for a further policy move, a number of members viewed conditions in financial markets as arguing for a steady policy course pending a reassessment early next year." The Committee issued a policy directive biased toward restraint, but waited until the subsequent meeting (January 31-February 1) to raise official rates another notch. Note: Alan Greenspan is scheduled to deliver the Fed's Humphrey-Hawkins testimony to Congress on February 22 and 23. CORPORATES Diane Garvey New issuance of corporate debt was fairly light for the week with approximately $2.2 billion issued through Thursday. some highlights far the week, include a $500MM Ford Motor Credit (A/A+) 7-year at +70BPs $400MM Legrand (A/A) 30-year at +95BPs, $300MM Associates Corp. N.A. putable 1O-year at +38BPs, and $250MM Shawmut Bank-N.A.(Baal/BBB) [Smith Barney was a co-manager) at +l15BPs. The calendar for the week of the 13th is building with the anticipation of a $1 billion debt offering from American Home Products toward the end of the week. As for secondary trading market activity was robust across the maturity spectrum and indiscriminate of industry sector. Interest in industrial paper remained strong throughout the week with tremendous flow business reported for cable companies. In particular. Time Warner's intention to merge with Cablevision Industries in a stock transaction including 2.5MM shares of Time Warner Inc.'s common and 3.25MM shares of two new series of convertible preferred as well as its "12-18 month initiative" including debt reduction, asset sales and intent to improve balance sheet measures caused spreads to tighten by 10-15BPs on intermediate paper and 20-25BPs on long paper. As for other cable companies like Tele-Communications Inc ('), spreads tightened at least 10-15BPs for intermediates and 10-15'BPs for the longer paper. Demand for higher rated industrials remained strong with spreads in Double A paper tightening on average by 2BPs for the week. Favorable operating results reported by Sears, Roebuck & Co, this week caused spreads on Sear's paper to tighten by 3BPs. US West Communication's paper tightened by 3BPs for the week due in part to the news emanating from Time Warner's announcement and US West's ownership stake in Time Warner Entertainment. Bank spreads ended the week 5BPs tighter on average. Price talk for Shawmut's bank deal widened to 115BPs from 105BPs which, at +115 was well received in the marketplace and tightened by 5BPs after the break. Demand for 12-15 year bank paper remained strong and spreads have tightened even more than 5BPs in certain cases. Canadian paper continued to see good flow and ended the week firmer by 3-5BPs. *Smith Barney usually maintains a market in the securities of this company. # Within the last: three years, Smith Barney, or one of its affiliates, was the manager (co-manager) of a public offering of the securities of this company or an affiliate. MUNICIPALS Too much money chasing too few notes and bonds caused the Short Term tax-exempt market to trade higher this week. Following last week's very positive employment figures, some buyers of short term tax exempt debt felt it was time to extend out on the curve by buying issues in the one to two year sector of the market. Corporations and Bond Funds had been investing in this sector over the past few months because longer term paper has been relatively less attractive. Indicative of the strong interest in this sector is the secondary market for the $4.0 Billion State of California RAWs which mature 4/25/96. After Friday's Employment number the RAWs improved 20 basis point from 5.30% to 5.10% . This past week RAWs continued to improve by 10 basis points and were not affected by the PPI number despite negative reactions in other markets. Mark Matthews For more information, go to internet, omnifest.uwm.edu, logon on as "visitor", then "go finance".