Long bond surpasses 6% mark as economy shows more gains.

The Treasury market took notice yesterday when statistics provided more evidence that the U.S. economy is gaining steam, and prices ended lower across the board.

The benchmark 30-year bond ended down more that 3/4 of a point, to yield 6.02%.

Sharper than expected increases on manufacturing and construction reports showed the economy may be healthier than had been thought.

The market sold off on the figures, as they suggested that these two lagging sectors of the economy are, building strength and beginning to contribute to gross domestic product growth instead of acting as a drag on it.

Coupled with other recent signs of buoyancy in the U.S. economy, investors are bracing themselves for a strong fourth quarter and a potential backup in interest rates.

Selling yesterday was broad-based, but the largest declines were in the intermediate sector. The middle of the yield curve has been hardest hit because of the upcoming supply burden from the Treasury Department's quarterly refunding auctions.

"The steady drumbeat of economic statistics continues to show strength," said William Sullivan, director of financial markets research at Dean Witter Reynolds Inc. "We are showing some vulnerability and anxiety about what's happening in the economy."

The National Association of Purchasing Management's composite index increased to 53.8% in October from 49.7% in September. The association's employment index rose to 45.5% from 44.5% in September. A reading above 50% indicates that the manufacturing sector is generally expanding, while a reading below 50% indicates it is generally declining.

Richard Peterson, chief economist at Continental Bank, noted that of the 20 industries in the manufacturing sector, 15 reported an improvement in the latest month, the most since March 1993, when 16 industry groups posted gains.

"The manufacturing sector is coming back," Peterson said.

The purchasing managers' report bodes well for the manufacturing sector and poorly for the bond market through the end of the year, said Peterson. However, he cautioned that recent signs of strength in the sector would be sustainable only if they are met by demand.

But the report is just one example of the many forces the bond market is up against in the fourth quarter of the year.

The construction sector provided another strong report on the economy yesterday. The Commerce Department reported that construction spending increased 0.8% in September, the fifth straight monthly rise.

The last string of five monthly increases was in 1987. The increase was generally in line with market expectations, but the department also reported large upward revisions for building activity in August and July. Outlays in August were up 0.5%, instead of the 1.1% drop originally reported, and July outlays surged 1.0% instead of the small gain of 0.1% last reported.

Peterson said that after August's weak reading, construction spending in the latest month has returned to levels more consistent with other trends in the economy.

"The improvement in construction and manufacturing means that [gross domestic product] growth in the fourth quarter of 1993 will be in excess of 4% and should come in around 3% for 1993," he said.

Despite expectations for a strong finish to the year, market participants look for economic growth to moderate once again in the first and second quarters of 1994.

Observers believe a number of factors will tend to hinder any acceleration of economic growth next year. They include uncertainty over upcoming health-care reform and associated higher taxes, ongoing corporate restructuring, the scale-back in the defense industry, the weak commercial real estate market, and the lack of new and innovative consumer products.

But in the meantime, the debate over the economy's direction rages on and market observers continue to dissect every economic report for fresh clues.

Traders generally agree that the employment report is the most important release this week, as it will provide the market with its first comprehensive view of the economy's performance in October.

Also slated for release this week are leading indicators for September and new home sales, also for September.

In other significant news this week, the Treasury Department will announce the size of its quarterly refunding package. Talk in the market Friday was that the Treasury may reopen the 5.75% 10-year note to head off what traders see as a protracted squeeze on the issue.

The Treasury Department announced yesterday that it projects fourth-quarter borrowing needs at $85.2 billion, including a $35 billion cash balance at the end of the quarter. Analysts generally agreed that the reduced borrowing needs are due in part to better cash balances at the end of September.

The weekly bill auctions came and went with little ado. The Treasury auctioned $13.5 billion of new 13-week bills at an average discount of 3.11%, up from 3.08% last week. The new 13-week bills will mature Feb. 3. The Treasury also sold $13.4 billion of 26-week bills at an average discount of 3.25%, up from 3.19% last week. The new 26-week bills will mature May 5. The investment rate was 3.18% on the 13-week bills at an average price of $9,921 per $10,000 face value. The rate on the 26-week bills was 3.35% at $9,836.

In futures, the September contract ended down 105/32 to 117.19.

In the cash markets, the 3 7/8% two-year note was quoted late yesterday down 5/32 at 99.17-99.18 to yield 4.10%. The 4 3/4% five-year note ended down 19/32 at 99.31-99.01 to yield 4.97%. The 5 3/4% 10-year note was down 33/32 at 101.12-101.16 to yield 5.54%. And the 6 1/4% 30-year bond was down 27/32 at 103.00-103.04 to yield 6.02%.

The three-month Treasury bill was up three basis points at 3.07%, the six-month bill was up four basis points at 3.23%, and the year bill was up six basis points at 3.40%.Treasury Market Yields Prev. Prev. Month Week Month3-Month Bill 3.07 3.05 2.976-Month Bill 3.23 3.18 3.101-Year Bill 3.40 3.31 3.322-Year Note 4.10 3.90 3.803-Year Note 4.37 4.19 4.105-Year Note 4.97 4.77 4.697-Year Note 5.14 4.99 4.8810-Year Note 5.54 5.41 5.3230-Year Bond 6.02 5.99 5.99Source: Cantor, Fitzgerald/Telerate

For reprint and licensing requests for this article, click here.
MORE FROM AMERICAN BANKER