Now that the 30-year bond has broken below the much-ballyhooed 6% yield level, Treasury market analysts are turning their sights on 5.50% as the next objective.
The 30-year bond closed almost 1 1/2 points higher Friday, to yield 5.93%, the lowest level in 25 years. The employment report for August provided further evidence that the economy is growing slowly but is not creating jobs or fueling inflation. Against that backdrop, market observers are forecasting lower yields for the market.
"There's no case for a substantial rise in rates and I'm not inclined to sell my bonds," said Robert DiClemente, director of bond market research at Salomon Brothers. noting his belief that the long bond could hit 5.50% in coming months.
DiClemente said participants have built a low inflation premium into the market, and with long-term rates at their lowest levels in 25 years, participants are likely to continue to extend the duration of their portfolios and buy bonds.
"I can't think of any better place to be in the next several months than the long end of the market," he said.
Neal Soss, chief economist at First Boston Corp., also believes the long bond could hit 5.50% by the end of the year. Soss cautioned that his outlook depends on the state of economic and inflationary growth, but said all indications in the real economy point toward a continuation of the slow growth scenario being played out in the bond market.
"There's little reason for worry about going forward," he said. Soss added that the upcoming health-care bill is likely be a supportive factor for the bond market. He argued that health-care reform is likely to result in a restructuring and employment losses in about one-seventh of the overall economy.
Raymond Stone, a managing partner at Stone & McCarthy Research Associates in Princeton, N.J., also believes that the yield on the longbond is good for another 50 basis points on the downside. However, his forecast is based more on fixed-income market dynamics than it is on developments in the economy.
"I don't think the economy in and of itself is a reason for lower rates," lie said. "Rates will move lower because there are portfolio shifts taking place as large funds move to the long end of the market." Stone said the low level of interest rates for bank deposits, particularly small-time deposits. continues to prompt a flow of money into Treasuries. He also believes the low level of long-term rates, which are likely to result in a pickup in prepayments for mortgages, will prolong the flow of mortgage money into Treasuries.
Participants said stepped-up prepayments on mortgages have posed problems for a number of brokerage firms, which have invested heavily in mortgage-backed securities and in mortgage-related strips this year, as the steady decline of long-term interest rates has taken even the market bulls by surprise. As prepayments increase along with declines in rates, dealers and investors have found themselves holding cash rather than bonds.
Along those lines, the market was buzzing late last week about the possibility of large losses at two primary dealerships that announced the resignations of traders. Salomon Brothers and Morgan Stanley & Co. reported resignations of strips traders on their mortgage-backed securities desks. Officials at both firms could only confirm that the traders had resigned.
Treasury market participants assumed that the resignations were tied to losses at both firms. "Reports are pretty sketchy, but a lot of people are concluding that losses on strips and other mortgage-backed products were behind the resignations," said one head trader at a primary dealership.
Treasury Market Friday
Treasury prices surged across the yield curve Friday in response to a weaker-than-expected August employment report, propelling the yield on the long bond below 6%.
The short end of the market also posted sharp gains on the numbers. Traders said the weak report has reignited hopes that the next change in monetary policy will be an ease.
Retail buyers jumped into the market this morning as the employment report for August posted larger payroll declines than analysts expected. Nonfarm payrolls dropped 39,000 in August, significantly, lower than expectations for an increase of 150,000. Manufacturing jobs fell 42,000, a]so off expectations for a decline of about 15.000.
Economists said the report confirmed the weakness, seen in recent data releases, that the economy remains weak and unable to generate new jobs.
Analysts pointed to some bright spots in the report, including a 0.5% increase in average hourly earnings and an increase of 400.000 civilian jobs in the household survey. But overall market analysts were encourage by the numbers and their implications for inflation.
Philip Braverman, chief economist at DKB Securities, said the drop in payrolls was consistent with the widespread signs of weakness in the economy.
Noting the strong performance at the front end of the curve this morning, analysts said the employment data are likely to change the Federal Reserve's bias on interest rate policy.
While no economists said they think the central bank will cut rates in response to this report, most agreed that further signs of weakness in upcoming data releases and a good round of inflation numbers this month could prompt an ease.
"The likelihood that an ease will be the next move over a tightening has been greatly enhanced by these numbers." said Marilyn Schaja, money market economist at Donaldson, Lufkin & Jenrette Securities Corp.
One reason why the market reacted so positively to the employment report was because it provided further evidence that the economy is expanding, but at a slower pace than at the end of 1992.
Brian S. Wesbury, chief economist at Griffin, Kubik, Stephens & Thompson as equally discouraged by the report and said that a number of factors, including events in Washington, are having a significant effect on consumer and business confidence and the real economy.
"It appears from August data that the tax bill and health-care bill are having a serious effect on employers." he said. "You don't get 5%, average growth in the fourth quarter of last year and an average of growth so far this year without big forces in play."
Another report released Friday painted a bleak picture of the housing sector. July home completions fell 8% to a 1.066 million rate. The decline was larger than expected and the lowest level since January 1992. The data added to the market's perception of a struggling economy.
In futures, the September contract ended Friday up 102/32 to 121.10.
In the cash markets, the 3 7/8% two-year note was quoted late Friday up 7/32 at 100.1 0- 100.11 to yield 3.69%. The 4 3/4% five-year note ended up 18/32 at 100.15-100.17 to yield 4.62%. The 5 3/4% 10-year note was up 26/32 at 103.14-103.16 to yield 5.29%. The 6 1/4% 30-year bond was up 45/32 at 104.09-104.11 to yield 5.93%.
The three-month Treasury bill was down four basis point at 2.95%, the six-month bill was down six basis points at 3.04%, and the year bill was down nine basis points at 3.13%.
Lanston President to Resign
James A. Rice will resign as president of Aubrey G. Lanston & Co., effective Dec. 31, the firm said Friday.
Rice joined Lanston in 1981 and became president and a member of the board of directors in 1990. He also headed up the firm's fixed-income trading operation in New York.
In a prepared statement, Richard M. Kelly, chairman and chief executive officer, said, "We accept Jim's resignation with deep regret. Jim has contributed importantly to Lanston during his tenure and he will be sorely missed. We wish him well in his future endeavors." Treasury Market Yields Prev. Prev. Friday Week Month3-Month Bill 2.99 3.08 3.086-Month Bill 3.10 3.20 3.271-Year Bill 3.22 3.37 3.482-Year Note 3.69 3.87 4.083-Year Note 3.99 4.20 4.365-Year Note 4.62 4.83 5.147-Year Note 4.87 5.08 5.4510-Year Note 5.29 5.48 5.8330-Year Bond 5.93 6.12 6.52 Source: Cantor, Fitzgerald/Telerate
