Said a Wall Streeter: “Investors have had a bad psychological shock.” The shock was a sudden drop in the price of long-term Government bonds. Last week’s drop, over two points in some issues, was the biggest in more than a decade, and it touched off a wave of selling which quickly spread to corporate and municipal bonds. The New York stockmarket, which had been showing signs of a year-end rally, was stopped in its tracks. Cause of all this: a surprise move by the Federal Reserve System which curbed credit.
The Federal Reserve Banks, which have been buying U.S. bonds whenever necessary to keep up their prices, decided that they were too high. The long-term bonds have been selling anywhere from one to three points above par. When the Federal Reserve Banks stopped buying, prices promptly dropped. Although Federal Reserve was mum on the new support level, Wall Streeters guessed that it might be just a shade above par.
By letting U.S. bond prices drop, Federal Reserve raised the yield on them slightly. Since Government bonds are the biggest factor in setting interest rates on all forms of business loans, Federal Reserve’s action will tend to force up all interest rates. This was a gesture to those who have complained that its failure to use all its powers to curb credit is letting the boom get out of hand. Credit would not be tightened much by the move, but it was a starter.
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