This Week in Capital Markets (12/18):

Will the Fed remain irrational?
Ed ZwirnDecember 18, 2000

It ain’t over ’til it’s over.

Maybe. With two more weeks left in the year, many execs and Wall Streeters are eager to call it a year.

For one thing, the widely anticipated (and long-awaited) “end” to the Presidential election has proved to be a dud.

But the five-week spectacle which occurred between the Nov. 7 election and last week’s Supreme Court decision, wiping out the last of Democrat Al Gore’s hopes, gave the markets too much time–if anything–to mull over the results.

The well-worn truisms about a victory by George W. Bush reflect “wisdom” that has already been priced in: stocks and corporate debt should fare better under the Republican government, while Treasury debt stands to lose, based upon the expectation that tax cuts will dilute deficit reduction.

But now, with the President-elect and Congress more closely divided than ever, most are wondering whether even these pat answers will have any meaning going forward.

From the time Bill Clinton was elected back in 1992 until his January inaugeration, long bonds fell 200 basis points. The markets knew he wasn’t an old tax-and-spend liberal.

Last week, the markets celebrated Bush’s victory by pounding stocks further. Trading levels for bonds were all over the place, varying by sector, with industrial and energy debt outperforming Treasuries by two or three basis points, and most other paper relatively unchanged, after some swings.

That still leaves one institution that the markets have reason to fear and/or respect.

It’s The Fed, Stupid

No, not the Supreme Court.

The markets may stand in awe of the Federal Reserve, whose Open Market Committee will meet on Tuesday to decide the true fate of the nation.

Recent remarks by Chairman Alan Greenspan have given financial markets ample reason to believe the next change in Fed monetary policy would be a shift in “bias” away from tightening and toward one officially “neutral” on the question of whether the economy has more to fear from a slowdown or a resurgence of inflation.

But, putting the matter into perspective, a shift in bias is actually a lot of smoke and mirrors. Bear in mind that the Fed didn’t even release its official “bias” statement as a matter of course until the past year or two.

Also, a bias shift has no immediate practical effect upon monetary policy. It is more of a forward indicator meant to cushion the reaction of a true change in rates at a later date.

Certainly, last week’s release of the November Producer Price Index and Consumer Price Index did nothing to change the widely-held perception that the economy is cooling off.

The PPI rose only 0.1 percent, less than expected by most forecasts. The “core” figure, excluding food and energy, actually remained flat.

The CPI increased by 0.2 percent, in line with forecasts. The core figure came in a little higher than most expected, at 0.3 percent.

While the CPI is slightly less bullish, the PPI represents information closer to the start of the economic pipeline and is therefore considered the leading indicator.

More to the point, neither report contained any information likely to rekindle inflation fears and derail the optimistic predictions of those waiting for a monetary easing.

In any event, the one immediate practical effect of the FOMC meeting will be to effectively shorten the week as far as financial markets are concerned. Many investors will straddle the fence, secondary trading volumes will be lighter, and few–if any–new issues will hit primary markets ahead of Tuesday afternoon.

At the end of the week, markets will be further truncated by the Bond Market Association’s recommendation for a 2 p.m. Friday close to all U.S. debt markets ahead of the Christmas weekend.

While secondary trading can be described as being in a “wait-and-see” mode ahead of Tuesday afternoon, primary issuance of both debt and equity appears to have slowed down to a trickle, at least through year-end.

In investment grade debt, syndicate desks are calling last Thursday’s Worldcom transaction the last major deal expected to hit the screens this year. J.P. Morgan arranged for the private placement of five- and 10-year bonds worth $2 billion. The bonds came on the heels of more than $15 billion of telecommunications debt (British Telecommunications and Verizon) just one week prior.

As a result, the issuer was forced to boost yields substantially to attract investors. The $1 billion five-year tranche priced to yield 7.419 percent, or 225 basis points over Treasuries, or some 10 basis points wider than the level at which deal managers initially tried to market it. In addition, the 10-year tranche, which can be redeemed by the company or sold back to the company after two years, was offered at a similar concession.

In the immediate pipeline, Baltimore Gas & Electric is said to be planning a $173 million offering of 12-year notes via Bank of America Securities and Lehman Brothers. The bonds, which will probably be A2/A-rated, will offer redemption and call provisions along the lines of the Worldcom issue.

Looking vaguely into the future, Unilever is still said to be planning a $1 billion offering of global bonds as a follow-up to the $7 billion it sold in October.

Also, Motorola, is planning an undetermined amount of euro-denominated single-A-plus-rated notes via its Motorola Credit Corp. unit. The deal, which will be managed by Morgan Stanley Dean Witter, will be the cellular phone maker’s first entry into the euro market.

Junk issuance is also creeping along. Continued outflows from junk mutual funds are only exacerbating this situation. And while the outlook for funding may be bleak for speculative-grade firms for the next several months, expect an even bleaker outlook through the end of the year.

The past week’s poster-child for the handicapped state of the junk bond market was PH Casino Resorts, which on Thursday was forced to scrub a planned merger with Pinnacle Entertainment due to bond market conditions. The firm reportedly balked upon hearing that investors were demanding another 25 basis points of yield before they would cough up the $675 million being sought. See our story

Looking ahead, Charter Communications may sell $1.2 billion at some point via Morgan Stanley Dean Witter and Goldman Sachs. The bonds are rated B2/B+.

Also said to be on the horizon is Spectrasite Holdings (B3/B-) with $200 million via CIBC.

IPOs Still Trickle

In the equity market, funding by way of IPOs appears to be at a relative standstill. Companies seeking to raise money via this avenue are still suffering from both the fallout from this year’s dot-com shakeout and general market conditions, with the Nasdaq continuing its dive.

The latest casualty in the department is Inconixx Corp. The Vienna, Va-based E- business, which had planned on enlisting the services of Donaldson, Lufkin & Jenrette, withdrew its planned $86.3 million offering early last week.

“Until the market stabilizes next year, the window is closed for technology stocks,” says a market specialist who analyzes pricing levels for a major New York brokerage firm. “The brokerage houses are really suffering a contraction in volume.”

The specialist, who declined to be identified, also contradicted the supposition that the emergence of Bush as President-elect is engendering unqualified optimism all around the Street.

“It’s not going to be as robust as it was over the past few years under the Clinton administration,” he says, referring to the prospects for new stock issuance. “My gut feeling is that all this fooling with taxes is not going to be that good for investment.”

Dupont Plans Spinoff On the other hand, one bit of news has surfaced that could make IPO fans happy.

The announcement by E.I. du Pont de Nemours and Co. (DuPont, to most of us) that it may separate its pharmaceuticals operations from the rest of the company might result in a new IPO in 2001. However, the company also said it might spin off or sell the unit instead.

According to a comment issued by Moody’s Investors Service shortly after the DuPont announcement, “The company will be able to command a significant premium for the business due to its current product portfolio and development pipeline.”