After weathering rough waters Friday, the market sails into this week's flotilla of economic reports and supply with the confidence of a seaworthy vessel.
The 30-year bond ended Friday's session down 6/32, to yield 6.21%.
Fundamentals and technical factors continue to underpin the market, and participants see few obstacles in the way of lower yields. That is particularly true for the long bond, which despite its problems Friday, should continue to lead the market into historically uncharted territory, participants said.
"The tone is still overwhelmingly positive and the market is very confident," said Anthony Karydakis, senior financial economist at First Chicago Corp.
Declines at the long end of the market Friday came at the hands of investors unwinding basis trades put on earlier in the week. A basis trade is one in which players bet against the spread between the yield of the cash bond and the yield of an off-the-run issue or a futures market issue.
Recent basis trades focused on the roll between the new and the old cash bonds. Last week, participants placed bets that the spread between the issues would widen further. Participants sold the futures contract and bought the cash bond.
But Friday, market players switched course and began positioning themselves for a narrower spread, which meant they sold the cash bond and purchased the futures contract. That activity allowed the futures market to outperform cash.
Gilbert Clark, government trading manager at Daiwa Securities America, said the participants were unwinding basis trades Friday as buying dried up and the yield of the cash bond seemed to bottom out for session.
"The market went the other way for a long time and it seems people reversed the trend," Clark said.
Selling of the cash bond benefited the rest of the Treasury issues, in that it allowed for some steepening of the yield curve and directed buying interest toward the short end.
Rumors that the Federal Reserve was buying intermediate notes also pushed prices higher and allowed the market to recover much of the losses posted Friday morning.
Widespread reports of the Fed buying five-, seven-, and 10-year notes propped up the middle of the curve and gave buyers impetus to make their way back into the market.
Participants speculated that the Fed was making purchases for the Bank of Japan in the wake of the BOJ's aggressive attempts to support the level of the U.S. dollar against the yen.
Tony Crescenzi, head fixed-income trader at Miller, Tabak, Hirsch & Co., said the Bank of Japan is reinvesting the dollars it purchases during intervention attempts in the Treasury market. "They have all those dollars and they're putting them to work in Treasuries," he said.
Crescenzi noted that talk of Fed purchases helped the market recover from early losses Friday.
Prices dipped at the start of the New York trading session. After putting in a solid performance during Tokyo trading hours and holding up relatively well in London, Treasury note and bond prices dipped during the morning as buyers left the market and some participants took profits in extremely thin trading.
Dealers said that a lack of buying interest was allowing prices to edge lower across the yield curve. With yields trading at historically low levels, participants said the market was suffering from a drought of fresh news to sustain the lofty price levels.
One New York-based trader of Japanese government bonds said that the rumors of Fed buying of Treasuries for the Bank of Japan prompted a flow of money out of Japanese bonds and into Treasuries. "Whether it happened or not, speculation that the Fed was in on behalf of the Bank of Japan attracted buyers to sell Japanese government bonds and buy U.S. government securities," the trader said.
Another trader of Japanese government bonds said that renewed calm in foreign exchange markets and expectations for the U.S. dollar to continue to rise against the yen further prompted Japanese investors to move money across markets.
There was no drought of remarks from central bankers Friday. Most notable was Alan Greenspan, chairman of the Federal Reserve. He said central bank officials are still capable of controlling short-term interest rates despite widespread changes in financial markets.
Fed open market operations no longer have "the fairly direct effect that they once had on credit flows to businesses and home builders," Greenspan told an economic symposium sponsored by the Federal Reserve Bank of Kansas City.
"Nonetheless, the Federal Reserve can still affect short-term interest rates, and thus have an impact on the cost of borrowing from banks, from other intermediaries, and directly in the capital markets," he said.
Greenspan acknowledged that today's more complex financial markets may require larger movements in rates and more time to affect the economy, but he added that "the Federal Reserve and other central banks still have the tools required to implement monetary policy."
Greenspan admitted that dramatic changes in M2 growth have undermined the Fed's ability to use the measure of money supply as a policy guide and to communicate their position to the markets. But he said that M2 may become useful again as the economy adjusts to changes in credit markets and as demand for credit revives.
But until then, Greenspan said, the Fed will rely more on economic and financial indicators to assess financial market conditions and the direction of the economy.
Observers generally concurred that the comments shed little light on the Fed's view of the economy or the direction of interest rates. However, some analysts said Greenspan's remark that the Fed still has the "tools" required to implement monetary policy may raise speculation of a cut in U.S. interest rates down the road.
"[Greenspan] seems to be laying the groundwork that says that the Fed needs to ease," said Robert Brusca, chief economist at Nikko Securities America. "One could reasonably draw that inference from what he said. "
On the monetary policy front, the Federal Open Market Committee voted 11 to 1 at its July meeting to maintain its policy stance toward a possible tightening of interest rates, minutes of the meeting released Friday reveal.
While the developments of that meeting were expected by the market, participants will keep a close eye on comments by Fed officials in the near future to look for clues of the central bank's current bias on interest rates.
This week the market will get its share of economic reports, including 10-day auto sales, July durable goods orders, July existing home sales, and a reading on consumer sentiment from the University of Michigan. The market will also absorb two- and five-year notes during the Treasury Department's monthly auctions.
Participants said the market will pay close attention to these developments to see if fundamentals continue to support the market at current yield levels.
In futures, the September contract ended up 23/32 to 117.09.
In the cash markets, the 4 1/4% two-year note was quoted late yesterday down 1/32 at 100. 19-100.20 to yield 3.91%; the 5 1/4% five-year note ended down 2/32 at 101.08-101.10 to yield 4.94%; the 6 1/4% 10-year note was unchanged at 101.00-101.02 to yield 5.60%; and the 7 1/8% 30-year bond was down 6/32 at 100.13-100.15 to yield 6.21%.
The three-month Treasury bill was down one basis point at 2.99%, the six-month bill was up one basis point at 3.11%, and the year bill was down two basis points at 3.28%.
Treasury Market Yields Prev. Prev. Friday Week Month3-Month Bill 3.03 3.06 3.146-Month Bill 3.18 3.19 3.311-Year Bill 3.38 3.38 3.612-Year Note 3.91 3.96 4.193-Year Note 4.28 4.35 4.515-Year Note 4.94 5.04 5.247-Year Note 5.22 5.34 5.5810-Year Note 5.60 5.70 5.9230-Year Bond 6.21 6.34 6.69Source: Cantor, Fitzgerald/Telerate
