Treasury prices took it on the chin Friday as the market reacted negatively to comments by Federal Reserve Chairman Alan Greenspan, who asserted his belief that the U.S. economy is on the rebound.
The 30-year bond ended Friday's session 3/4 of a point lower, to yield 5.97%.
Greenspan, during a speech in Washington, said that the "50-mile per hour headwinds" that the economy had been struggling with "have now come down to about 25 miles per hour."
The Fed chairman's optimistic assessment of economic fundamentals sent shock waves through the market and forced Treasury prices lower. It also sent investors back to the drawing board to see if they have missed some factors in the economy that point toward stronger growth.
Observers thought the market overreacted to Greenspan's remarks, and said they believed that the Fed chairman put a relatively positive spin on his outlook for the economy. They also agreed that the vulnerable state of the market and lack of fresh statistics on the economy exaggerated the move.
The December bond contract broke below an a long-standing psychological support level at 119.26 as stop-loss sell orders were triggered in an extremely thin market. Friday's sell-off in futures extended losses seen earlier in the week when commodity prices surged in response to a rate cut by the-German central bank.
Friday's price action prompted many investors to rethink their view on the economy. Market players generally agree that fundamentals continue to support Treasuries and that recent economic statistics, which have indicated that some sectors of the economy are improving, are secondary to the fact that inflation remains low.
A lack of consensus among market participants about the direction of the U.S. economy and the absence of significant economic indicators on which to focus has left the market in a tenuous position, participants said.
"Recent price action is not unusual," said Samuel Kahan, chief economist at Fuji Securities. "We're seeing the normal kind of violent price fluctuations which take place when people are undecided on where the market is heading."
Still, the market's sharp sell-off last week spooked investors and fueled speculation that the great bond market rally of 1993 was over. Improvement in the Philadelphia Fed's survey of manufacturing activity and housing starts statistics added more fuel to the speculative fire.
In addition, a newspaper report last week said that two influential investors, George Soros and Michael Steinhardt, believe U.S. Treasury bond prices will fall and are betting substantial sums on that view. The story reported that that Soros and Steinhardt have taken sizable short positions in bonds.
Because a lack of consensus on the direction of the market has made Treasuries even more vulnerable than would normally be the case, Kahan suggests that investors take a more defensive stance on the market.
Retail accounts have found this to be good advice.
James Somers, president of Somers Asset Management, said he is avoiding long positions at the long end of the Treasuries yield curve due to illiquidity in the market, as well as the skittishness of investors. He said the sharp sell-off last week took most investors by surprise and sent a sobering blow to those who began thinking of the 30-year bond as a bullet-proof investment.
"A lot of guys got slammed around and accounts are going to position themselves in ways to shield their money from losses," Sommers said.
While the jury is still out on whether the economy has entered a period of sustained growth, some observers said the recent dynamic of Treasuries indicates that the market fundamentals remain intact. Some analysts pointed to the performance of the short end of the market and the shape of the yield curve as evidence that investors have not given up on the market.
Normally, the first sign of a bearish shift in market sentiment is a followed by a flattening of the yield curve. But during the bulk of this year, the yield curve's tendency was to flatten during rallies and steepen when prices fell. As long as the market holds this pattern, price declines are more likely to be reflective of technical corrections or range-trading than a shift in market psychology, observers said.
Anthony Karydakis, senior financial economist at First Chicago, said expectations for steady monetary policy have and will continue to keep the short end of the Treasury yield curve locked in place, while the bulk of the price movements have taken taken place at the long end.
"Nothing has changed on the fundamentals front, and it will take more than a couple of days of violent sell-offs to conclude that the rally is over," Karydakis said.
Karydakis and other observers were encouraged that the yield on the 30-year bond did not rise to 6%, a level which see as a badge of the market's strength. A yield below 6% means that market is in good shapeTreasury Market Yields Prev. Prev. Friday Week Month3-Month Bill 3.04 3.01 2.976-Month Bill 3.15 3.10 3.101-Year Bill 3.29 3.24 3.342-Year Note 3.89 3.77 3.873-Year Note 4.15 4.01 4.135-Year Note 4.74 4.57 4.757-Year Note 4.93 4.72 4.9510-Year Note 5.39 5.15 5.3830-Year Bond 5.97 5.78 5.96Source: Cantor, Fitzgerald/Telerate
fundamentally, while a yield above that means the market is entering into a period of declines, analysts contend.
If there is a bright side to last week's declines, Karydakis said it is that higher yield levels could bring retail buyers back into the market. In what has become a recurring theme for Treasuries, sharp selling merely pushed yields higher and brought buyers back into the market.
Participants generally believe the market will maintain recent ranges until this week's round of economic statistics, which include gross domestic product report, dumble goods orders, and existing home sales.
In futures, the September contract ended down 29/32 to 118.30.
In the cash markets, the 3 7/8% two-year note was quoted late Friday-down 3/32 at 99.30-99.31 to yield 3.89%, the 4 3/4% five-year note ended down 7/32 at 99.30-100.00 to yield 4.74%, the 5 3/4% 10-year note was 16/32 lower at 102.19-102.22 to yield 5.39%, and the 6 1/4% 30-year bond was down 24/32 at 103.21-103.25 to yield 5.97%.
The three-month Treasury bill was down one basis point at 3.04%, the six-month bill was unchanged at 3.15%, and the year bill was up two basis points at 3.29%.
